Cost Of Capital Of Perpetual Debt

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The cost of capital of perpetual debt (i.e., debt availed by the firm on a regular basis) may be ascertained as follows:

                     ki  =   I /  Bo

 where      ki   =   Cost of capital  of debt ( before )
                  I      =    Annual Interest Payable
                  Bo =   Net Proceeds

A few points are worth noting in equation

1.    The equation calculates the cost of capital of debt before tax. The tax adjustment will be taken up later.
2.    The repayments (periodic amortization or maturity repayment ) have not been considered as the debt is taken as perpetual. It may be noted that the concept of perpetual debt is theoretical in nature, otherwise debt, being a type of a loan is always repayable. Even if one debt is replaced by another, still there may be difference in interest rate of two debt instruments or difference in redemption amount and the net proceeds.

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