Cost of Debt
The effective rate that a company pays on its current debt; it can be measured as either before-tax 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
Companies use bonds, loans, and other forms of debt for capital; this measure is useful because it indicates the overall rate being
used for debt financing. It also gives investors an idea of how risky a company can be; riskier companies generally have a higher cost of debt. To get the after-tax rate, multiply the before-tax rate by 1 minus the marginal tax rate (before-tax rate × (1 - marginal tax)). For example, if a company's only debt was a single bond in which it paid 5%, the before-tax cost of debt would be 5%. If, however, the company's marginal tax rate was 40%, the company's after-tax cost of debt would be only 3% (5% × (1 -40%)).
Related Terms:
• Capital Structure
• Cost of Capital
• Debt Financing
• Discounted Cash Flow—DCF
• Interest Rate
