hard · Principles of Finance

If the yield on a firm's outstanding bonds is 7%, but the bonds were issued with a 4% coupon, which rate should be used as the pre-tax cost of debt in the WACC calculation?

1. 9.33%, the yield adjusted for the firm's equity β.
2. 5.5%, the average of the coupon and the current yield.
3. 4%, because that is the actual cash interest expense the firm is paying.
4. 7%, because it represents the current market opportunity cost and the rate at which the firm could issue new debt today.

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