The Cost Of Debt is the effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. This is one part of the company's capital structure, which also includes the [[Cost of Equity]].

The formula can be written as:
$\Large (R_f + \text{credit risk rate})(1-T)$

where
$\Large T$  is the corporate tax rate and
$\Large R_f$ is the risk free rate.

A company will use various bonds, loans and other forms of debt, so this measure is useful for giving an idea as to the overall rate being paid by the company to use debt financing. The measure can also give investors an idea as to the riskiness of the company compared to others, because riskier companies generally have a higher cost of debt.

To get the after-tax rate, you simply multiply the before-tax rate by one minus the marginal tax rate (before-tax rate x (1-marginal tax)). If a company's only debt were a single bond in which it paid 5%, the before-tax cost of debt would simply be 5%. If, however, the company's marginal tax rate were 40%, the company's after-tax cost of debt would be only 3% (5% x (1-40%)). 
bag
finance_public
created
Sat, 05 Feb 2011 08:40:12 GMT
creator
dirkjan
modified
Sat, 05 Feb 2011 08:40:12 GMT
modifier
dirkjan
tags
M12
Term
WACC
creator
dirkjan