Principles of Managerial Finance, 15th Edition

9.2 Cost of Long-Term Debt

1. LG3

Firms that borrow money pay interest to lenders. That interest is a cost to the borrower, but interest alone does not fully reflect a firm’s borrowing cost. First, if a firm borrows money by issuing bonds, it will incur costs specifically tied to the process of issuing new securities, separate from the interest payments made on those securities. In addition, in the United States, the tax laws allow firms to treat interest payments as a tax-deductible expense². That deduction reduces a firm’s taxes, and thereby reduces the cost of debt. The cost of long-term debt, r_d, is the financing cost associated with new funds raised through long-term borrowing, taking into account the firm's interest payments and other ...