Cost Of Debt

Loading the player...

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%)).

RELATED TERMS
  1. After-Tax Return

    The return on an investment including all income received and ...
  2. After-Tax Profit Margin

    A financial performance ratio, calculated by dividing net income ...
  3. After-Tax Income

    The amount of money that an individual or company has left over ...
  4. Pretax Rate Of Return

    The rate of return on an investment that does not take the taxes ...
  5. Discounted After-Tax Cash Flow

    An approach to valuing an investment that looks at the amount ...
  6. Debt-To-Capital Ratio

    A measurement of a company's financial leverage, calculated as ...
Related Articles
  1. Retirement

    How IRA Contributions Affect Your Taxes

    Learn how to work with the tax man to avoid getting gouged when you convert your plans.
  2. Personal Finance

    Target Corp: WACC Analysis (TGT)

    Learn about the importance of capital structure when making investment decisions, and how Target's capital structure compares against the rest of the industry.
  3. Taxes

    How After-Tax Rollovers Affect Your IRA

    Consolidating retirement assets? Make sure you account for pre-tax and after-tax assets separately.
  4. Investing Basics

    Will Corporate Debt Drag Your Stock Down?

    Borrowed funds can mean a leg up for companies or the boot for investors. Find out how to tell the difference.
  5. Options & Futures

    Financial Statements: Long-Term Liabilities

    By David Harper (Contact David)Long-term liabilities are company obligations that extend beyond the current year, or alternately, beyond the current operating cycle. Most commonly, these include ...
  6. Taxes

    After-Tax Balance Rules For Retirement Accounts

    Accumulating post-tax assets can work to your advantage. Find out how.
  7. Economics

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  8. Markets

    EVA: Pulling It All Together

    By David Harper, (Editor In Chief - Investopedia Advisor) Contact David By working through the components of economic profit over the previous chapters, we've been building an economic profit ...
  9. Taxes

    Retirement Plan Tax Form 8606: When To File

    If you have a Roth IRA, you are responsible for keeping track of your pretax versus after-tax assets.
  10. Credit & Loans

    Companies Offering Debt Consolidation

    Debt consolidation companies might be the answer for the 35% of Americans who have some debt that has moved past due and is in a collections status.
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

    Discover how to calculate the ratio between debt and equity when making cost of capital estimations using the weighted average ... Read Answer >>
  3. What is the difference between cost of debt capital and cost of equity?

    Learn about how the costs of debt and equity capital differ and how to calculate each using interest and tax rates and stock ... Read Answer >>
  4. How does a company choose between debt and equity in its capital structure?

    Learn about the benefits and drawbacks of debt and equity financing and how companies compare different capital structures ... Read Answer >>
  5. What do people mean when they say debt is a relatively cheaper form of finance than ...

    In this case, the "cost" being referred to is the measurable cost of obtaining capital. With debt, this is the interest expense ... Read Answer >>
  6. How do interest rates influence a corporation's capital structure?

    Learn about how changing interest rates can affect a corporation's capital structure because of their impact on the cost ... Read Answer >>
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center