Question

When estimating the cost of debt capital for the firm, we are primarily interested in

A) the cost of short-term debt.
B) the cost of long-term debt.
C) the coupon rate of the debt.
D) none of the above.

Answer 1

The correct answer is option B) the cost of long-term debt.

Step-by-step explanation:

When estimating the cost of debt capital for a firm, we are interested in the cost of long-term debt. This interest in long-term debt arises because these debts are typically significant in value and have a substantial impact on the firm's financial structure. The cost of long-term debt is more relevant for calculating the firm's cost of capital because it relates directly to the firm's ability to finance its operations over an extended period.

Short-term debt, on the other hand, is usually associated with ongoing working capital requirements and does not usually affect the company's long-term planning and investment decisions in the same way. Furthermore, the relevant cost measure for long-term debt is not the coupon rate of the debt alone but the effective interest rate that the firm pays, which considers tax effects and other factors.