What is Net Interest Cost (NIC)
Net interest cost (NIC) is a mathematical formula that an issuer of bonds uses to compute the overall interest expense that is associated with their bonds, which they will have to pay. 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.
BREAKING DOWN Net Interest Cost (NIC)
Net interest cost is one method that companies use to compare bids from underwriter syndicates. When a company issues a bond, they usually sell the bonds to a syndicate of underwriters, who, in turn, sell the bonds to the public. Thus, companies will try to get the best price from underwriters – they want underwriters that produce the least amount of interest costs over the life of the loan. But it's not the only way. NIC takes into account any premium or discount applicable to the issue, as well as the dollar amount of coupon interest payable over the life of the issue. Because NIC doesn't incorporate the time value of money, other tactics can be used to obtain actionable information about the quality of an underwriter's bid. When a debt issuer uses the NIC to evaluate their underwriter bids, they'll usually contract with the syndicate offering the lowest net interest. However, this may not be the best method for selecting underwriters who may have a low NIC, but have a higher TIC (total interest cost) over the lifetime of the bond.
The Net Interest Cost Calculation
The NIC formula was created before the widespread use of computers and is a simple, straightforward calculation based on available bond information. The formula is:
Net Interest Cost = (Total Interest Payments + Discount - Premium) / Number of Bond-Year Dollars
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.
As an example of the net interest calculation, consider Company ABC, which wants to calculate the 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 NIC formula for this example is:
NIC = ($4,000,000 - $250,000) / $100,000,000 = .0375 or 3.75 percent
NIC is expressed as a percentage. The net interest cost does not incorporate the time value of money. To take the time value of money into account, you need to use the "true interest cost" method, also called the "present worth" method.