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Estimating Cost of Debt
The cost of debt is the return provided to the debtholders and creditors of a company. These investors are given a return to compensate for the risk that comes with lending money.
Observable interest rates often contribute to quantifying cost of debt. Therefore, the cost of debt of a company reflects both its risk of default as well as the interest rates in the market. Additionally, it is also a component in calculating Weighted Average Cost of Capital (WACC).
There are two methods to calculating cost of debt:
Calculating the yield to maturity (YTM) of a company’s debt
Determining the cost of debt by referencing the credit rating of the firm
This cost of debt calculator uses the first calculation method. If a company is public, it can have observable debt in the market. We can look at the company’s bonds and use the values mentioned above to solve for the YTM of the bond. It is best to use this method when the company you are looking at has a simple capital structure. If it has a more complicated capital structure with multiple tranches of debt, there will be multiple differing interest rates.
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Below is a break down of subject weightings in the FMVA® financial analyst program. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy.
A well rounded financial analyst possesses all of the above skills!
Additional Questions & Answers
CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path.
In order to become a great financial analyst, here are some more questions and answers for you to discover:
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