Cost of Debt

Definition

Cost of debt is the effective interest rate a company pays on its borrowings. In WACC, debt is often adjusted for taxes because interest can be tax deductible.

Formula

After-tax cost of debt ~ cost of debt * (1 - tax rate)

Example

If cost of debt is 7% and tax rate is 25%, after-tax cost of debt ~ 7%*(1-0.25) = 5.25%.

How to use it

• Use the company's current borrowing rate for similar maturity and risk.
• Remember the tax shield: after-tax cost of debt is lower than the nominal coupon.
• Use the weighted average rate if multiple debt instruments exist.
• Include fees and amortized costs when estimating effective debt cost.

Common mistakes

• Using old debt coupons when the firm's risk or rates have changed.
• Forgetting the tax shield when using WACC as a discount rate proxy.
• Ignoring fees or amortization costs that raise effective rates.
• Using short-term debt rates to price long-term cash flows.

Why this matters

This term matters because cash timing and risk are usually the difference between a plan that works on paper and a plan that survives. Use consistent definitions so decisions are comparable over time.

Practical checklist

• Write a 1-line definition for "Cost of Debt" that your team will use consistently.
• Keep the time window consistent (weekly/monthly/quarterly) when comparing trends.
• Segment results (channel/plan/cohort) before drawing big conclusions from blended averages.
• Use a calculator that references this term (e.g., WACC Calculator) to sanity-check assumptions.
• Read the related guide (e.g., WACC explained: how to estimate a discount rate for DCF) for context and common pitfalls.

Where to use this on MetricKit