Cost of debt 

is the required rate of return on debt capital of a company. Where the debt

is publicly-traded, cost of debt equals the yield to maturity of the debt. If market price of
the debt is not available, cost of debt is estimated based on yield on other debts
carrying the same bond rating.

The yield to maturity approach is useful where the market price of debt is available.

Yield to maturity (YTM) equals the internal rate of return of the debt, i.e. it is the
discount rate that causes the debt cash flows (i.e. coupon and principal payments) to
equal the market price of the debt. Where the market price is not available, yield to
maturity cannot be worked out but a relative approach can be used to estimate cost of
debt. Under the relative approach, called the bond-rating approach, cost of debt equals
the average yield to maturity of similar bonds, i.e. bonds carrying the same credit rating.

Cost of debt is an important input in calculation of the weighted average cost of capital.

WACC equals the weighted average of cost of equity and after-tax cost of debt based
on their relative proportions in the target capital structure of the company.

The coupon rate is the amount of annual interest income paid to a

bondholder, based on the face value of the bond. Government and non-
government entities issue bonds to raise money to finance their operations.
When a person buys a bond, the bond issuer promises to make periodic
payments to the bondholder, based on the principal amount of the bond, at
the coupon rate indicated in the issued certificate. The issuer makes
periodic interest payments until maturity when the bondholder’s initial
investment – the face value (or “par value”) of the bond – is returned to the
bondholder.

How Bond Coupon Rates Work

A bond's coupon rate denotes the amount of annual interest paid by the bond's
issuer to the bondholder. Set when a bond is issued, coupon interest rates are
determined as a percentage of the bond's par value, also known as the "face
value." A $1,000 bond has a face value of $1,000. If its coupon rate is 1%, that
means it pays $10 (1% of $1,000) a year.

Coupon rates are largely influenced by prevailing national government-controlled

interest rates, as reflected in government-issued bonds (like the United
States' U.S. Treasury bonds). This means that if the minimum interest rate is set
at 5%, no new Treasuries may be issued with coupon rates below this level.
However, preexisting bonds with coupon rates higher or lower than 5% may still
be bought and sold on the secondary market.1

When new bonds are issued with higher interest rates, they are automatically
more valuable to investors, because they pay more interest per year, compared
to pre-existing bonds. Given the choice between two $1,000 bonds selling at the
same price, where one pays 5% and the other pays 4%, the former is clearly the
wiser option