There are two costs of debt finance.The explicit cost of debt is the rate of interest that bondholders demand.But there is also an implicit cost, because borrowing decreases the required rate of return to equity.

Question

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The implicit cost of debt refers to the increased risk and required rate of return to equity that comes from taking on debt, not a decrease in the required rate of return to equity. Borrowing can lead to higher expectations of returns from equity holders due to the increased financial risk.

There Are Two Costs of Debt Finance