After-tax cost of debt

Definition

After-tax cost of debt is the net cost a company incurs on its debt after accounting for tax deductions. It is an important measure as interest expenses are tax-deductible, reducing the overall expense of borrowing.

5 Must Know Facts For Your Next Test

1. The formula for after-tax cost of debt is: Interest Rate * (1 - Tax Rate).
2. It reflects the true financial burden of debt on a company.
3. Interest payments on debt reduce taxable income, hence lowering the tax liability.
4. After-tax cost of debt is typically lower than the nominal interest rate due to tax savings.
5. It plays a crucial role in calculating the Weighted Average Cost of Capital (WACC).

Review Questions

• How do you calculate the after-tax cost of debt?
• Why is after-tax cost of debt usually lower than the nominal interest rate?
• What role does after-tax cost of debt play in WACC calculations?

Related terms

Weighted Average Cost of Capital (WACC):

A company's overall cost of capital from all sources, including equity and debt.

Tax Shield:

The reduction in income taxes that results from taking an allowable deduction from taxable income.

Cost of Equity:

The return required by shareholders for investing in a company's equity.