HyPo Ltd has estimated its cost of debt in 2005 using net interest/average net debt to be 8.45 per cent.The 10- year bond yield was 6.50 per cent in 2005 and 6.95 in 2006.Using a risk premium approach,what would be the estimation of the firm's current cost of debt?

Question

Quizplus · Accepted Answer

The risk premium approach estimates the cost of debt as the risk-free rate plus a risk premium. The risk-free rate is typically represented by the 10-year bond yield. The risk premium is the difference between the cost of debt and the risk-free rate. In this case, the risk premium is 8.45% - 6.50% = 1.95%.To estimate the current cost of debt, we need to add the risk premium to the current 10-year bond yield. The current 10-year bond yield is 6.95%. Therefore, the current cost of debt is 6.95% + 1.95% = 8.90%.

HyPo Ltd Has Estimated Its Cost of Debt in 2005