Cost of Capital: Cost of Debt

A firm's before$-$tax cost of debt, rd$,$ is the interest rate that the firm must pay on

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debt. Because interest is tax deductible, the relevant cost of

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debt used to calculate a firm's WACC is the

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cost of debt, rd$(1$ T$).$ The

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cost of debt is used in calculating the WACC because we are interested in maximizing the value of the firm's stock, and the stock price depends on

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cash flows. It is important to emphasize that the cost of debt is the interest rate on

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debt, not

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debt because our primary concern with the cost of capital is its use in capital budgeting decisions. The rate at which the firm has borrowed in the past is

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because we need to know the cost of

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capital. For these reasons, the

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on outstanding debt $($which reflects current market conditions$)$ is a better measure of the cost of debt than the

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$.$ The

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on the company's

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$-$term debt is generally used to calculate the cost of debt because, more often than not, the capital is being raised to fund

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$-$term projects.