Cost Of Debt

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What is the 'Cost Of Debt'

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.

BREAKING DOWN 'Cost Of Debt'

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%)).

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RELATED FAQS
  1. Do companies measure their cost of debt with before- or after-tax returns?

    Understand the before and after-tax calculations of cost of debt capital and how each is useful in deciding between funding ... Read Answer >>
  2. How do you calculate the ratio between debt and equity in the cost of capital

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  3. How does opportunity cost impact how cost of debt is evaluated?

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  4. What is the difference between cost of debt capital and cost of equity?

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  5. How does a company choose between debt and equity in its capital structure?

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