8.7 : Calculating Cost of Debt

Calculating the cost of debt is a fundamental aspect of financial analysis for any business, especially when evaluating the affordability and impact of its borrowing strategy. When considering how to finance business operations or expansion, companies have a range of debt options, such as bank loans, bonds, or commercial paper. The decision often involves a thorough analysis of the cost of debt, among other factors.

When choosing among these options, companies consider factors like interest rates, credit ratings, tax implications, and terms and conditions. Interest expense is generally tax-deductible. Companies factor this into their cost analysis to determine the true cost of borrowing. More debt can negatively impact a company's credit rating, making future borrowing more expensive. Companies must balance their need for funds with the potential impact on their financial health.

Ultimately, the choice of debt depends on the company's specific financial situation, strategic objectives, market conditions, and the relative costs of different financing options. By carefully evaluating these aspects, companies select the most cost-effective and strategic debt financing method to meet their needs.