Tuesday, March 16, 2010


Cost of Capital - Debt Issued at Par

The before tax cost of debt is the rate of return required by lenders. It is easy to compute before tax cost of debt issued and to be redeemed at par,

It is simple equal to the conceptual of interest.

For example, a company decides to sell a new issue of 7 year 15% bonds of 100$ each at par. If the company realizes the full face value of 100$ bond and will pay 100$ principle to bondholders at maturity, the before tax cost of debt will simply be equal to the rate of interest of 15$. Thus:

Kd =i = Interest / Bo

Where Kd is the before tax cost of debt, i is the coupon rate of interest, Bo is the issue price of the bond and in equation it is assumed to be equal to the face value, and interest is the amount of interest. The amount of interest payable to the lender is always equal to:

Interest = Face value of debt X Interest rate

No comments: