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.
Measured as
After-tax cost of debt ~ cost of debt * (1 - tax rate)
Misused when
- 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.
Operator takeaway
- 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.
- Tie Cost of Debt to the same balance-sheet date, scenario, and decision memo you are using elsewhere in the model.
- Document which claims, costs, or adjustments your team includes before comparing numbers across forecasts, covenants, or valuation work.
Next decision
- Quantify the impact with WACC Calculator if you need to turn the definition into an operating assumption.
- Read WACC explained: how to estimate a discount rate for DCF if the decision depends on interpretation, policy, or trade-offs beyond the raw formula.
Where to use this on MetricKit
Calculators
- WACC Calculator: Calculate WACC (Weighted Average Cost of Capital) from capital structure, cost of equity, cost of debt, and tax rate.
Guides
- WACC explained: how to estimate a discount rate for DCF: A practical guide to WACC: what it is, how to compute it, and how to use it (carefully) as a DCF discount rate.
- Interest expense: definition, formula, and how to calculate: Interest expense explained: what it is, the formula, how to calculate it, and how net interest expense works.