Estimating Cost of Capital Measures Sprint Nextel Corporation (S) has $24.3 billion in total debt (which approximates its market value.) Each year this debt costs the company about $1.5 billion in interest expense. The company's market capitalization approximates $17.2 billion, its market beta is estimated 2.12, and its marginal tax rate is 35%. Assume that the risk-free rate equals 5.3% and the market premium equals 5.7%. Rounding Instructions: Do not round until your final answers. Round answers to one decimal place. (a) Estimate Sprint Nextel's cost of debt capital.

Answer: 4.0%

Explanation:

Given the following;

Total debt = $24.3billion

Tax rate = 35%

Interest paid on debt = $1.5billion

While raising funds for a corporation, companies capital are based on either sales of stock (equity). The other source of capital may be based on the sale of bonds or the taking loans or other sources that culminate into debt. Capital raised through bonds and loans are all classed as debt and the interest paid on them is called the cost of debt capital. However, capital raised and classed as debt are tax free.

Cost of debt capital = [ (interest on debt : total debt) * (1 - tax rate) ]

Cost of debt capital = [ ($1.5 : $24.3) * (1 - 0.35) ]

Cost of debt capital = $ (1.5 / 24.3) * (0.65) = 0.040

0.040 * 100 = 4. 0%

Sprint Nextel's cost of debt capital is $ 975,000,000

Explanation:

Cost of Debt Capital is the Interest charge incurred by a Company for holding debt sources of finance.

There is a tax shield for interest charged on debts thus the cost of debt must exclude tax charge.

This cost of debt is usually used to determine the Company's Cost of Capital along with other sources of finance it possesses.

Cost of Debt = Interest * (1 - tax)

= $1 500 000 000 * (1 - 0.35)

=$1 500 000 000 * 0.65

=$ 975,000,000