The cost of bonds and debentures measures the current cost of the firm of borrowing funds to finance the projects. In general, it is determined by the following variables:

i)    The current level of interest rates. As the level of interest rates increases, the cost of debt for the firm will also increase.
ii)    The default risk of the firm. As the default risk of the firm increases the cost of bonds and debentures also increases. One way of measuring the default risk is to use the bond rating for the firm; higher credit rating leads to lower interest rates, and lower rating leads to higher interest rates.
iii)    The tax advantages associated with the debt. Since, the interest is tax deductible, the after-tax cost of debt is a function of tax rate. The tax benefit that  accrues from paying interest makes the after tax cost of debt lower than the pre tax cost.      

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