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Cost of Debt

Definition

The effective interest rate a company pays on its borrowings, adjusted for the tax deduction.

How It Works

Pre-tax cost is the yield on existing debt. After-tax cost = Rd × (1-T) because interest is tax-deductible.

Formula

After-tax Rd = Rd × (1 - T)

Example

If a firm borrows at 6% and the tax rate is 25%, after-tax cost of debt = 6% × 0.75 = 4.5%.

Common Misconceptions

✗Use the coupon rate (use YTM instead)
✗No need to tax-adjust

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FAQs

Common questions about Cost of Debt

Take the weighted average YTM across all outstanding debt.

The coupon rate is set at issuance and stays fixed. YTM reflects the current market return required by debt investors. Since WACC should use current costs, YTM is the correct input.