Final answer:
The pre-tax cost of new debt issued by a firm that closely resembles its existing debt should be roughly similar to the Yield to Maturity (YTM) of the outstanding debt, presuming stable market conditions and unchanged credit risk.
Step-by-step explanation:
If a firm is considering issuing new debt that closely resembles the already outstanding debt issue, the new debt issue should have a pre-tax cost of debt roughly similar to the YTM (Yield to Maturity) on the already outstanding debt issue. The YTM reflects the current market interest rates and is considered a benchmark for issuing new debt with similar characteristics. If market conditions have not changed dramatically, and the firm's credit risk profile remains constant, the cost of the new debt should be comparable to the YTM of the existing debt.
The cost of new debt can be influenced by changes in interest rates. If interest rates have risen since the old debt was issued, the firm might have to offer a higher interest rate on the new debt to make it attractive to investors, hence increasing its cost. Conversely, if interest rates have fallen, the new debt could potentially be issued at a lower cost. However, if the interest rates have remained stable, the cost of new debt should closely align with the existing debt's YTM.
In conclusion, issuing debt similar to existing debt generally implies that the pre-tax cost of the new issue will likely be similar to the existing debt, assuming market conditions and the issuer's creditworthiness remain unchanged. Significant deviations from the current YTM would typically arise from changes in the broader interest rate environment or the issuer's financial health.