# Calculating Cost of Debt: YTM and Debt-Rating Approach

Cost of debt refers to the cost of financing a company using debt such as a bond issue or bank loan. It is stated as an interest rat rD. Since there is a tax shield on the interest component of debt, the component used in WACC is rD (1 –t)

In this article, we will estimate the cost of debt using two approaches: Yield-to-Maturity approach, and Debt-Rating approach.

Yield-to-Maturity Approach

The yield to maturity is the annual return from an investment purchased today and held till maturity, i.e., it is the rate at which the current market price of the bond is equal to the present value of all the cash flows from the bond.

Let’s take an example to understand this.

Assume that a company has issued a bond to raise funds.

Par$1,000 Market value$1,050
Coupon8%
Coupon paymentSemi-annual
Maturity10 year

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