1. What is Cost of Debt?

Cost of Debt represents the effective rate a company pays on its current debt. It's calculated as the after-tax cost since interest expenses are tax-deductible, reducing the actual cost to the company.

2. How Does the Calculator Work?

The calculator uses the cost of debt formula:

Where:

• \( \text{Interest Rate} \) — The interest rate on the debt (percentage)
• \( \text{Tax Rate} \) — The corporate tax rate (percentage)

Explanation: The formula accounts for the tax shield benefit, where interest payments reduce taxable income, thereby lowering the effective cost of borrowing.

3. Importance of Cost of Debt Calculation

Details: Calculating cost of debt is crucial for capital budgeting decisions, determining weighted average cost of capital (WACC), evaluating financing options, and assessing overall financial health of a company.

4. Using the Calculator

Tips: Enter the interest rate as a percentage (e.g., 5 for 5%), and the corporate tax rate as a percentage (e.g., 25 for 25%). Both values must be valid percentages between 0 and 100.

5. Frequently Asked Questions (FAQ)

Q1: Why is cost of debt calculated after-tax?
A: Interest expenses are tax-deductible, so the government effectively subsidizes part of the interest cost through tax savings.

Q2: What is a typical cost of debt range?
A: It varies by company credit rating and market conditions, but typically ranges from 3% to 10% for investment-grade companies.

Q3: How does cost of debt affect WACC?
A: Cost of debt is a key component of WACC. Lower cost of debt reduces overall WACC, making investments more attractive.

Q4: Should I use pre-tax or after-tax cost of debt for analysis?
A: For most financial analyses, after-tax cost of debt should be used since it reflects the actual cost to the company.

Q5: How do different types of debt affect the calculation?
A: For companies with multiple debt instruments, calculate weighted average interest rate across all debt types before applying the tax adjustment.