Net Interest Cost (NIC)

What Is Net Interest Cost (NIC)?

Net interest cost (NIC) is a mathematical formula used to compute the overall interest expense of a bond issue. The formula for net interest cost (NIC) is based on the average coupon rate weighted to years of maturity and is adjusted for any associated discounts or premiums.

Understanding Net Interest Cost (NIC)

Net interest cost (NIC) is one method that companies use to compare bids from underwriter syndicates. When a company issues a bond–reaching out to a pool of investors to lend it money over a specified period of time in exchange for a payment–they usually sell them to a syndicate of underwriters. This temporary group of investment banks and broker-dealers are then responsible for selling the bonds to the public.

Companies will try to get the best price from underwriters. They want underwriters that produce the least amount of interest costs, the cumulative amount a borrower pays on a debt obligation over the life of the loan. That means that when a debt issuer uses the net interest cost (NIC) to evaluate their underwriter bids, they'll usually contract with the syndicate offering the lowest net interest. This may not be the best method for selecting underwriters as some may have a low net interest cost (NIC), but a higher total interest cost (TIC) over the lifetime of the bond.

Net interest cost (NIC) takes into account any premium or discount applicable to the issue (that is, whether the bond is selling above or below face value). It also factors in the dollar amount of coupon interest, which is the periodic rate of interest paid by the issuers to its purchasers over the life of the bond. Net interest cost (NIC) is expressed as a percentage.

Calculating Net Interest Cost (NIC)

The net interest cost (NIC) formula is a simple, straightforward calculation based on available bond information. The formula is:

_{ $Net Interest Cost (NIC) = (Total Interest Payments + Discount - Premium) / Number of Bond-Year Dollars$NetInterestCost(NIC)=(TotalInterestPayments+Discount−Premium)/NumberofBond−YearDollars}

The "number of bond-year dollars" equals the sum of the product of each year's maturity value and the number of years to its maturity.

Example of Net Interest Cost (NIC)

Company ABC wants to calculate the net interest cost (NIC) on its most recent bond issue. If total interest payments on the debt total $4,000,000, the premium was $250,000, and the number of bond-year dollars is $100,000,000, then the net interest cost (NIC) formula would be:

Net interest cost = ($4,000,000 - $250,000) / $100,000,000 = .0375 or 3.75%.

Limitations of Net Interest Cost (NIC)

The net interest cost is just one way to compute the overall interest expense of a bond issue. One of its biggest flaws is that it does not incorporate the time value of money (TMV): the concept that money available today is worth more than the same amount in the future, due to its potential earning capacity.

To take the time value of money (TMV) under consideration, it is necessary to use the "true interest cost (TIC)" method. TIC includes all ancillary fees and costs, such as finance charges, possible late fees, discount points, and prepaid interest, along with factors related to the TMV.