The cost of debt is determined by taking one of the following: a) the historical yield on bonds...

Question:

The cost of debt is determined by taking one of the following:

a) the historical yield on bonds times one minus the tax rate.

b) the estimated yield on new bond issues of the same risk times one minus the shareholder marginal tax rate.

c) the present value of the interest payments and principal times one minus the tax rate.

Cost Of Debt:

The cost of debt is important to determine as capital budgeting decisions require WACC in order to analyze the profitable opportunities for the investment. There are various approaches to determine the cost of debt.

Answer and Explanation:

The cost of debt is determined by taking one of the following:

b) the estimated yield on new bond issues of the same risk times one minus the shareholder marginal tax rate.

The new bond issue would be based on the current risk profile of the firm and is hence the most accurate method.


Let's analyze other options:

a) the historical yield on bonds times one minus the tax rate. - The historical yield changes over time and is hence not a good measure.

c) the present value of the interest payments and principal times one minus the tax rate. - This would not provide us with the rate but rather cash flows.


Learn more about this topic:

Loading...
Long-Term Debt: Definition, Cost & Formula

from Financial Accounting: Help and Review

Chapter 8 / Lesson 7
35K

Related to this Question

Explore our homework questions and answers library