Question

Lewis Bros. currently has outstanding debt but has decided to issue additional debt for expansion purposes. The pretax cost of the new debt is best estimated at the ________ of the currently outstanding debt.

Answer 1

Answer: b. current yield to maturity

Step-by-step explanation:

Interest rates charged on debt are primarily based on the risk of the borrower being able to pay back the debt. The higher the risk, the higher the interest rate charged.

The risk of not paying (default) back the debt is higher when the borrower already has existing debt. This is why in such instances, the interest on the new debt will be based on the yield to maturity (interest rate) of the existing debt so that the risk of default is adequately accounted for.