Alternatively, there are several financial data services that publish betas for companies. But it can be cumbersome to pay back interest until its loans are paid off—especially when interest rates are rising. Capital is the money a business—whether it’s a small business or a large corporation—needs and uses to run its day-to-day operations. Capital may be used to make investments, conduct marketing and research, and pay off debt. Keeping the cost of debt minimized in a sustainable manner also favors your financial standing and credit rating.

The mix of debt and Equity is vital for a company and should always be at a reasonable level. However, there is no metric for how much debt a company should have compared to its Equity.

How Do Cost of Debt Capital and Cost of Equity Differ?

If the debt will end up producing growth that’s more valuable than the cost, then the loan is a good business investment. The first approach is to look at the current yield to maturity or YTM of a company’s debt. An example would be a straight bond that makes regular interest payments and pays back the principal what is the cost of debt at maturity. The cost of debt is the return that a company provides to its debtholders and creditors. These capital providers need to be compensated for any risk exposure that comes with lending to a company. Let’s say you want to take out a loan that will allow you to write off $2,000 in interest for the year.

In most cases, the firm’s current capital structure is used when beta is re-levered. However, if there is information that the firm’s capital structure might change in the future, then beta would be re-levered using the firm’s target capital structure. The risk-free rate is the return that can be earned by investing in a risk-free security, e.g., U.S. It’s called risk free because it is free from default risk; however, other risks like interest rate risk still apply.

Using a business credit card

Finally, divide total interest expense by total debt to get the cost of debt or effective interest rate. In summary, the cost of debt influences both the Debt to Equity Ratio and WACC, playing an essential role in determining https://www.bookstime.com/articles/operating-cycle a company’s capital structure. Understanding these key financial metrics helps businesses make informed decisions about their financing options to optimize their capital structure and maximize shareholder value.