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Cost of Debt

The calculation of the cost of debt is relatively easy. The cost of funds raised through debt in the form of debentures or loan from financial institutions can be determined from Eq. 12.1. To apply the formulation of explicit cost of debt, we need data regarding; (i) the net cash proceeds/inflows (the issue price of debentures/amount of loan minus all flotation costs) from specific source of debt, and (ii) the net cash outflows in terms of the amount of periodic interest payment and repayment of principal in installments or in lump sum on maturity. The interest payments made by the firm on debt issues qualify for tax deduction in determining net taxable income. Therefore, the effective cash outflows is less than the actual payment of interest made by tile firm to the debt holders by the amount of tax shield on interest payment. The debt can be either perpetual, irredeemable or redeemable.

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