CFA Practice Question

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CFA Practice Question

The before-tax cost of debt capital for a firm ______
A. is the return that the firm's creditors demand on new borrowing.
B. can be estimated by finding the yield on recently issued, longer-maturity bonds with a lower bond rating.
C. can be calculated by looking at the coupon rates on existing bonds of similar risk.

User Contributed Comments 7

User Comment
danlan C: might be correct if changed to "can be estimated".
anricus This does not take into account the tax rate. I thought the cost of debt was Mk rate of interest * (1-tax rate)
sevaa1 the question asks for the "before-tax" cost of debt, so the taxes do not need to be taken into account here.
sheenalim why is B wrong?
sbhatia B is wrong in part because we have no idea if "longer maturity bonds" will apply to the firm at hand. They could be looking at both short-term and medium-terms issues what could potentially demand a different rate.

A is clearly right because it is the most direct measure of required interest rate.
NickGerli C would be correct if it added "and same maturity."
kingirm C is correct. It is even given in the AN LOS.
A might be correct for the "next" debt issue of the firm but for existing debt C must hold correct.
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