Cost of new debt includes dividend
A great topic!
When evaluating the cost of new debt, it's common to include the dividend yield of the company in the calculation. This is because the dividend yield represents the return that shareholders expect to receive from the company, and it can be seen as an opportunity cost of taking on new debt.
The cost of new debt, also known as the weighted average cost of capital (WACC), is the rate of return that a company must pay to its investors, including both debt and equity holders. The WACC takes into account the cost of debt, the cost of equity, and the tax benefits of debt.
To calculate the WACC, you can use the following formula:
WACC = (E/V x Re) + (D/V x Rd x (1 - T))
Where:
- E/V is the market value of equity divided by the total value of the company (V)
- Re is the expected return on equity
- D/V is the market value of debt divided by the total value of the company (V)
- Rd is the yield on debt
- T is the corporate tax rate
The dividend yield can be included in the calculation of the cost of equity (Re) or the cost of debt (Rd), depending on the context.
If you're using the dividend yield to estimate the cost of equity, you can use the following formula:
Re = D1 / P0 + g
Where:
- D1 is the expected dividend payment in one year
- P0 is the current stock price
- g is the expected growth rate of dividends
This formula assumes that the expected return on equity is equal to the dividend yield plus the expected growth rate of dividends.
If you're using the dividend yield to estimate the cost of debt, you can use the following formula:
Rd = D1 / P0 + r
Where:
- D1 is the expected debt payment in one year
- P0 is the current market value of the debt
- r is the expected return on debt (e.g., the yield on a similar bond)
This formula assumes that the expected return on debt is equal to the debt payment divided by the market value of the debt, plus the expected return on a similar bond.
In summary, including the dividend yield in the calculation of the cost of new debt can help you estimate the expected return that shareholders expect to receive from the company, which can be used to evaluate the cost of new debt and make informed investment decisions.