What is cost of debt in a capital stack and how do you calculate it?

• A. It is the coupon rate of the first-lien debt only.
• B. It is the tax rate on interest.
• C. It is the overall project yield ignoring debt.
• D. Weighted average rate on all funded debt; computed as sum(debt amount * rate) / total debt.

Answer: (D)

In a capital stack, the cost of debt is the blended rate the project pays on all funded debt, not just the coupon of the first-lien loan, and not the税 rate or a project-wide yield that ignores financing. To calculate it, take each debt tranche, multiply its outstanding amount by its interest rate, sum these products, and divide by the total funded debt. This weighted-average rate across all debt components shows the true financing cost of the debt portion. In many models you’ll then adjust to an after-tax cost for WACC calculations (multiply by 1 minus the tax rate) since interest is tax-deductible, but the basic cost of debt is this weighted average across all debt.