Cost of Debt Calculator
This cost of debtCost of DebtThe cost of debt is the return that a company provides to its debtholders and creditors. Cost of debt is used in WACC calculations for valuation analysis. calculator is used to calculate the annual yield to maturityYield to Maturity (YTM)Yield to Maturity (YTM) – otherwise referred to as redemption or book yield – is the speculative rate of return or interest rate of a fixed-rate security, such as a bond. The YTM is based on the belief or understanding that an investor purchases the security at the current market price and holds it until the security has matured of a company’s debtDebtDebt is the money borrowed by one party from another to serve a financial need that otherwise cannot be met outright. Many organizations use debt to procure goods and services that they can’t manage to pay for with cash., otherwise known as its cost of debt or the interest rateInterest RateAn interest rate refers to the amount charged by a lender to a borrower for any form of debt given, generally expressed as a percentage of the principal.. This calculator takes the following values for its inputs:
- bond face valuePar ValuePar Value is the nominal or face value of a bond, or stock, or coupon as indicated on a bond or stock certificate. It is a static value determined at the time of issuance and, unlike market value, it doesn’t fluctuate on a regular basis.
- bondBondsBonds are fixed-income securities that are issued by corporations and governments to raise capital. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period. price
- number of years to maturity
- couponCoupon BondA coupon bond is a type of bond that includes attached coupons and pays periodic (typically annual or semi-annual) interest payments during its lifetime and its par value at maturity. These bonds come with a coupon rate, which refers to the bond's yield at the date of issuance. payment period (e.g. monthly, quarterly, etc.)
- coupon rateCoupon RateA coupon rate is the amount of annual interest income paid to a bondholder, based on the face value of the bond.
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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)WACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula is = (E/V x Re) + ((D/V x Rd) x (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator.
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 ratingCredit RatingA credit rating is an opinion of a particular credit agency regarding the ability and willingness an entity (government, business, or individual) to fulfill its financial obligations in completeness and within the established due dates. A credit rating also signifies the likelihood a debtor will default. 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 structureCapital StructureCapital structure refers to the amount of debt and/or equity employed by a firm to fund its operations and finance its assets. A firm's 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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