The cost of debt capital is the interest rate a firm would have to pay to its bondholders if they raise new funds by selling new bond issues.
- Coupon rate of bonds is not the cost of debt
Finding the effective cost of debt:
- The YTM on existing debt of the firm that are traded in the market, or YTM of comparable bonds with the same bond rating as the firm’s current bonds.
- Effective cost of debt to the firm is after tax, because interest paid on debt is a tax-deductible expense.
- Effective cost of debt = YTM (1 – corporate tax rate)