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 does the stock market react to changes in the Federal Funds Rate?

    The stock market reacts to changes in the federal funds rate in various ways depending on where it is in the business cycle. ... Read Full Answer >>
  5. What is the relationship between the current yield and risk?

    The general relationship between current yield and risk is that they increase in correlation to one another. A higher current ... Read Full Answer >>
  6. What is the difference between a Debit Order and a Standard Order in a bank reconciliation?

    While both debit orders and standard orders represent recurring transactions that must be considered in bank reconciliations, ... 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. Professionals

    Top 10 Airlines to Work For in 2015

    Find out why Southwest Airlines and JetBlue lead the list of the top airlines to work for in 2015.
  5. Mutual Funds & ETFs

    ETF Analysis: Powershares DB US Dollar Bullish Fund

    Explore information and detailed analysis of two popular currency exchange-traded funds, the PowerShares DB U.S. Dollar Bullish and Bearish Index Funds.
  6. Mutual Funds & ETFs

    ETF Analysis: Market Vectors Gold Miners

    Learn about Market Vectors Gold Miners, one of the most volatile ETFs in the market, which fell 75% from 2011 to 2015 after climbing 300% from 2008 to 2011.
  7. Investing

    Who Supports Donald Trump's Campaign?

    Explore the common characteristics among voters who prefer Donald Trump for the 2016 election, including youth, modest incomes and lack of education.
  8. Mutual Funds & ETFs

    The 5 Biggest ETF Companies

    Review a list of the five largest and most influential ETF providers in the world: BlackRock, Vanguard, State Street, Deutsche Bank AWM and Invesco.
  9. Investing

    Advising FAs: Explaining Annuities to a Client

    Conceptually speaking, annuities can be thought of as a reverse form of life insurance.
  10. Investing

    Advising FAs: Explaining ETFs to a Client

    Exchange traded funds (ETFs) have exploded in popularity with both investors and professionals for several reasons, and their growth shows no sign of slowing.

You May Also Like

Hot Definitions
  1. Dog And Pony Show

    A colloquial term that generally refers to a presentation or seminar to market new products or services to potential buyers.
  2. Topless Meeting

    A meeting in which participants are not allowed to use laptops. A topless meeting organizer can also ban the use of smartphones, ...
  3. Hedging Transaction

    A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging ...
  4. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  5. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  6. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
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!