Net interest cost (NIC) is a percentage that reflects the total cost to the issuer for issuing the bond. Typically a lower NIC is better for the issuer than a higher NIC because it reflects a lower cost to the issuer.
NIC can be calculated with the following formula:
NIC = (total interest payments + discount (or – premium)) / total bond year dollars
The NIC is a ratio of the total interest payments until the bonds are retired plus any discount that the bonds are sold for, divided by bond year dollars.
The denominator of the equation, total bond year dollars represents the sum of the dollar amount of all outstanding bonds multiplied by the time (in years) they are outstanding. Note that bond years are the number of bonds outstanding (in $1,000 denominations) multiplied by the number of years they are outstanding. So in this equation, one bond year represents one $1,000 worth of bonds that matures in one year. A $5,000 bond that matures in 5 years would be equal to $25,000 bond year dollars, and 25 bond years.
If the bonds are to be issued at a discount, the amount of the discount is added to total interest payments because this amount will need to be paid by the issuer. If the bonds are to be issued at a premium, that amount is subtracted from the interest total.
Example: Imagine an issuer is selling $10 million of bonds at five different maturities. The bond is a serial issue with higher interest rates for the longer maturities. Bond year dollars are calculated by multiplying the years to maturity by the par value at each maturity. Bond years are calculated by dividing the bond year dollars by $1,000.
