Cost Of Debt

AAA

DEFINITION of '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.

INVESTOPEDIA EXPLAINS '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%)).

RELATED TERMS
  1. Levered Free Cash Flow

    The free cash flow that remains after a company has paid its ...
  2. Cost Of Capital

    The required return necessary to make a capital budgeting project, ...
  3. Optimal Capital Structure

    The best debt-to-equity ratio for a firm that maximizes its value. ...
  4. Cost Of Equity

    In financial theory, the return that stockholders require for ...
  5. Capital Budgeting

    The process in which a business determines whether projects such ...
  6. Weighted Average Cost Of Capital ...

    A calculation of a firm's cost of capital in which each category ...
RELATED FAQS
  1. Why should a company buy back shares it feels are undervalued instead of redeeming ...

    Repurchase and redemption are associated with different classes of stock. Common shares can be bought back by the issuing ... Read Full Answer >>
  2. How does monetary policy impact the cost of debt?

    Monetary policy influences short-term interest rates, and the cost of debt is defined as the effective interest rate paid ... Read Full Answer >>
  3. Do companies measure their cost of debt with before- or after-tax returns?

    Cost of debt is most easily defined as the interest rate lenders charge on borrowed funds. When comparing similar sources ... Read Full Answer >>
  4. How can I increase my standard of living in my retirement years?

    If you're decades away from retirement, the best way to ensure a decent standard of living during your golden years is to ... Read Full Answer >>
  5. What is each party's role in a reverse repurchase agreement?

    There are two principal parties in a reverse repurchase agreement. The first party, often called the seller, is offering ... Read Full Answer >>
  6. Can I get a tax credit from conducting research and development?

    It is possible for a company to qualify for a research and development tax credit for conducting research and development. ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Discounted Cash Flow Analysis

    Find out how analysts determine the fair value of a company with this step-by-step tutorial and learn how to evaluate an investment's attractiveness for yourself.
  2. Bonds & Fixed Income

    Investors Need A Good WACC

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality.
  3. Fundamental Analysis

    Taking Stock Of Discounted Cash Flow

    Learn how and why investors are using cash flow-based analysis to make judgments about company performance.
  4. Savings

    Explaining Term Deposits

    A term deposit (more often called a certificate of deposit or CD) is a deposit account that is made for a specific period of time.
  5. Economics

    What is a Resident Alien?

    A resident alien is a foreigner who is a permanent resident of the country in which he or she resides but does not have citizenship.
  6. Investing Basics

    Understanding Related-Party Transactions

    In business, a related-party transaction refers to a transaction where parties on both sides have a common interest or relationship.
  7. Economics

    Explaining Protectionism

    Protectionism is government measures that limit imports into a country to protect commerce within that country against foreign competition.
  8. Economics

    Understanding Organizational Behavior

    Organizational behavior is the study of how humans interact in group environments.
  9. Economics

    What is a Leasehold Improvement?

    A leasehold improvement is an alteration made to a rented space that customizes the space for the tenant.
  10. Fundamental Analysis

    Understanding the Profitability Index

    The profitability index (PI) is a modification of the net present value method of assessing an investment’s attractiveness.

You May Also Like

Hot Definitions
  1. American Dream

    The belief that anyone, regardless of where they were born or what class they were born into, can attain their own version ...
  2. Multicurrency Note Facility

    A credit facility that finances short- to medium-term Euro notes. Multicurrency note facilities are denominated in many currencies. ...
  3. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
  4. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  5. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  6. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!