Question

A firm's before-tax cost of debt, rd, is the interest rate that the firm must pay on debt. Because interest is tax deductible, the relevant cost of debt used to calculate a firm's WACC is the cost of debt, rd(1 – T). The cost of debt is used in calculating the WACC because we are interested in maximizing the value of the firm's stock, and the stock price depends on cash flows. It is important to emphasize that the cost of debt is the interest rate on debt, not debt because our primary concern with the cost of capital is its use in capital budgeting decisions. The rate at which the firm has borrowed in the past is because we need to know the cost of capital. For these reasons, the on outstanding debt (which reflects current market conditions) is a better measure of the cost of debt than the . The on the company's -term debt is generally used to calculate the cost of debt because, more often than not, the capital is being raised to fund -term projects.

Answer 1

Answer:

The blank spaces are not easy to spot here but I found a similar question with their correct locations. The answers for each blank will be as follows respectively;

new; new ; after-tax cost of debt ; after-tax cost of debt ; after-tax cashflows; new debt; not outstanding debt ; irrelevant ;new capital; yield to maturity; coupon rate; yield to maturity; long term debt ; long-term projects.

Explanation:

The cost of new debt is the before-tax cost of debt and does not reflect the cost of outstanding debt. Interest paid on the new debt is tax-deductible and that's why you calculate the after-tax cost of debt to use in the firms WACC formula. Since the main goal of a business managers is to increase a firm value, you use the after tax cashflows to valuate the business. Additionally, the cost at which the firm borrowed in the past is irrelevant in WACC calculation because the cost we need to know is of the new capital.