Economics Capital Budgeting Questions
There are several methods used for estimating the cost of debt in capital budgeting. These methods include:
1. Yield to maturity (YTM) approach: This method calculates the cost of debt by considering the present value of all future cash flows from the debt instrument, including interest payments and the principal repayment at maturity.
2. Credit rating approach: This method estimates the cost of debt based on the credit rating assigned to the company by credit rating agencies. The cost of debt is determined by referencing the yield on bonds with similar credit ratings.
3. Debt market approach: This method involves analyzing the prevailing interest rates in the debt market and determining the cost of debt based on the rates offered on similar debt instruments.
4. Company's historical cost of debt: This method considers the historical interest rates paid by the company on its existing debt to estimate the cost of debt for future capital budgeting decisions.
5. Survey approach: This method involves conducting surveys or market research to gather information on the interest rates offered by various lenders or financial institutions, which can be used to estimate the cost of debt.
It is important to note that the choice of method may vary depending on the availability of data, the specific circumstances of the company, and the preferences of the decision-makers.