Calculate the pre-tax and after-tax cost of debt from interest expense and total debt, an interest rate, or a bond’s price and yield to maturity.

Average interest-bearing debt over the year gives the most accurate rate.

Prefilled with the 21% US federal corporate rate. Enter your effective rate, or 0 for the pre-tax cost only.

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Cost of Debt Formula

The following formulas are commonly used to estimate a company’s cost of debt (a rate) and the related after-tax interest expense (a dollar amount).

rd & = (IE) / (AvgDebt)\ CoDafter & = rd(1 - (TR) / (100))\ AfterTaxIE & = IE(1 - (TR) / (100))
  • Where rd is the pre-tax cost of debt (rate, % per year)
  • IE is the annual interest expense ($)
  • AvgDebt is average interest-bearing debt over the period ($)
  • TR is the corporate tax rate (%) used for the interest tax shield
  • CoDafter is the after-tax cost of debt (rate, % per year)
  • AfterTaxIE is the after-tax interest expense ($)

To calculate the after-tax cost of debt rate, first estimate the pre-tax cost of debt (for example, interest expense divided by average debt, or a bond’s yield to maturity), then multiply by (1 − TR/100).

Cost of Debt Definition

The cost of debt is the effective interest rate a company pays (or must pay) on its interest-bearing debt. From the lender or bondholder’s perspective, it is the required rate of return for providing debt financing. In corporate finance (for example, when calculating WACC), the cost of debt is often used on an after-tax basis because interest expense is generally tax-deductible.

Cost of Debt Example

How to calculate cost of debt?

  1. First, determine the annual interest expense.

    For this example, we will say the annual interest expense is $100,000.00.

  2. Next, determine average total debt and the tax rate.

    Assume the company has $2,000,000.00 of average interest-bearing debt and a 25% tax rate.

  3. Finally, calculate the pre-tax and after-tax cost of debt.

    Pre-tax cost of debt = $100,000 / $2,000,000 = 0.05 = 5%. After-tax cost of debt = 5% * (1 - 0.25) = 3.75%.

FAQ

What is a cost of debt?

The cost of debt is the interest rate a company pays on its interest-bearing liabilities (or the return demanded by debt holders). It can be expressed on a pre-tax basis (for example, interest expense divided by average debt, or a bond’s yield to maturity). For WACC and many valuation uses, the after-tax cost of debt is often used and is typically estimated as r_d × (1 − T).