What is the Cost of Debt?

This is also known as “Cost of Borrowed Capital”.
Cost of debt is the percentage of ‘burden’ in relation to ‘net proceeds’. In this context the burden can be defined as the annual rate of interest agreed to be paid, plus other related costs.
It is a usual practice for a company to procure borrowed funds by issuing debentures or bonds. While doing so the amount of net proceeds which the company actually receives (for use in business) is less than the face or par value of such debentures or bonds. This is so because the company has to incur certain expenses such as floatation expenses or issue expenses. All these expenses or costs are deducted from the amount of the issue and the balance represents the net proceeds, actually available to the company for use in the business. Therefore, the cost is computed as a percentage of interest burdens on the net proceeds actually received for use in business.