What is the definition of cost of debt?

The cost of debt refers specifically to the effective rate that a company pays on its borrowed funds. This is best encapsulated by the option that describes it as the rate of return required by investors. This definition encompasses the obligation of the company to provide a return to those who have lent it money. It is crucial for a firm to ensure that it can cover its debt obligations in order to maintain its creditworthiness and attract further investment.

In a financial context, the cost of debt is typically calculated as the weighted average interest rate on all of the company's debt, taking into account the tax deductibility of interest expenses. Since interest payments on debt are generally tax-deductible, the actual out-of-pocket cost for a firm is reduced, making the return required by investors lower when considering the tax shield.

Understanding this concept is fundamental for a company to effectively evaluate investment opportunities and manage its capital structure, balancing debt and equity to minimize its overall cost of capital. Therefore, the option that identifies the cost of debt as the rate of return required by investors aligns accurately with the accepted financial definition.