Cost of Debt Calculator
Calculate the cost of debt — both the pre-tax interest rate and the after-tax rate that matters for WACC and capital budgeting. The tax shield makes debt cheaper than its stated interest rate, and this calculator shows exactly how much.
What Is the Cost of Debt?
The cost of debt is the effective rate a company pays on its borrowed money. It is not just the stated interest rate — because interest payments are tax-deductible, the after-tax cost of debt is lower than the pre-tax rate.
For example, if a company borrows at 8% and pays 30% corporate tax, the after-tax cost of debt is 8% × (1 − 0.30) = 5.6%. The government effectively subsidizes 30% of the interest cost. This tax shield is why debt is often cheaper than equity in WACC calculations.
Cost of Debt Formula
After-tax cost of debt:
After-Tax Cost of Debt = Pre-Tax Rate × (1 − Tax Rate)
Pre-tax rate with risk premium:
Pre-Tax Rate = Base Interest Rate + Risk Premium
- Pre-tax rate — what the lender charges (yield to maturity on new debt)
- Tax rate — the company's effective corporate tax rate
- Tax shield — pre-tax rate minus after-tax rate; the interest deduction benefit
Worked Example
A company borrows at 8% pre-tax, with a 30% corporate tax rate:
After-tax cost of debt = 8% × (1 − 0.30) = 5.60%
Tax shield = 8% − 5.60% = 2.40%
On $10,000 of debt, the annual interest payment is $800, but the tax deduction saves $240 of tax — so the effective cost to the company is only $560 per year.
This is why debt is attractive in WACC calculations — its after-tax cost is usually 30–40% lower than the stated interest rate.
Where Cost of Debt Is Used
- WACC — the after-tax cost of debt is weighted by the debt proportion to calculate the weighted average cost of capital.
- Capital budgeting — projects must return more than the after-tax cost of debt to create value.
- Capital structure decisions — companies compare the cost of debt to the cost of equity when deciding how much to borrow.
- Valuation — WACC, which uses cost of debt, is the discount rate in DCF valuation.
Frequently Asked Questions
What is a good cost of debt?
Lower is better. Investment-grade companies typically borrow at 3–6% pre-tax. Below investment grade, rates jump to 6–10%+. In a low-rate environment, even below-investment-grade debt can be 4–5%. The after-tax cost is typically 30–40% lower than the pre-tax rate — for example, a 6% pre-tax rate with a 25% tax rate becomes 4.5% after-tax.
Why is after-tax cost of debt used in WACC?
Because interest is tax-deductible, so the actual cost to the company is lower than the stated rate. If a company borrows at 8% but deducts the interest from taxable income, the government effectively pays 30% of the interest bill. Using the pre-tax rate in WACC would overstate the cost of capital, understate valuations, and lead to rejecting profitable projects.
How do I estimate the cost of debt for a private company?
For a private company, use the interest rate on its most recent bank loan or bond issuance. If no public debt exists, estimate from comparable public companies — find the average yield on bonds issued by similar businesses and add a spread for private company risk (typically 1–3% higher than comparable public debt).
What is the risk premium on debt?
The risk premium is the extra yield investors demand for taking on credit risk above a risk-free benchmark. For a company with a BBB credit rating, the spread over government bonds might be 1.5–2.5%; for a BB-rated company, 3–4%. This calculator lets you add a risk premium on top of the base rate to model this scenario.
Does the cost of debt include fees and flotation costs?
The simplest cost of debt calculation uses only the interest rate. For more accurate analysis, include fees: origination fees, legal costs, and any commissions paid when issuing debt. These fees increase the effective cost. For a large bond issuance with 2% fees, the effective cost might be 0.3–0.5% higher than the stated coupon.
Should I use the marginal or average cost of debt?
For WACC and capital budgeting, use the marginal cost of debt — the rate the company would pay on new borrowing today, not the average rate on existing debt. The reason: WACC is used to evaluate new projects, so the relevant cost is what new debt would cost, not what existing (older, possibly lower-rate) debt costs. Average cost of debt is only useful for historical analysis.