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Fundamentals of Financial Management, Third Edition by Vyuptakesh Sharan

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7.2 COMPUTATION OF THE COST OF CAPITAL

Since there are different forms of capital in a firm’s capital structure, the cost for each type of capital is measured exclusively, then, along with their respective weights, all these costs are combined to arrive at the weighted average cost of capital.

7.2.1 Cost of Debt

The cost of debt (Kd) is the interest rate mentioned in the instrument subject to the adjustment for taxes. Cost of debt can be expressed in the form of an equation as follows:

Where:

    I = the interest rate

    T = the tax rate

 

EXAMPLE

If a firm has debentures carrying 5% coupon and if the tax rate is 30%, the cost of debt will ...

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