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Unformatted text preview: However, flotation costs are typically small on public debt issues, and, more important, most debt is placed directly with banks, insurance companies, and the like, and in this case flotation costs are almost nonexistent. Optional Question Should you use the nominal cost of debt or the effective annual cost? Answer: Our 10 percent pretax estimate is the nominal cost of debt. Since the firm's debt has semiannual coupons, its effective annual rate is 10.25 percent: (1.05) 2 1.0 = 1.1025  1.0 = 0.1025 = 10.25%. However, nominal rates are generally used. The reason is that the cost of capital is used in capital budgeting, and capital budgeting cash flows are generally assumed to occur at yearend. Therefore, using nominal rates makes the treatment of the capital budgeting discount rate and cash flows consistent. Mini Case: 10  14...
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.
 Spring '08
 Staff
 Debt, Interest, Interest Rate

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