1. What is Cost of Debt?

The cost of debt represents the effective interest rate a company pays on its borrowed funds after accounting for tax benefits. It's a crucial component in calculating a company's weighted average cost of capital (WACC).

2. How Does the Calculator Work?

The calculator uses the cost of debt formula:

Where:

• Coupon Rate — The interest rate stated on the bond (as decimal)
• Tax Rate — The corporate tax rate (as decimal)

Explanation: The formula accounts for the tax deductibility of interest expenses, which reduces the actual cost of debt for corporations.

3. Importance of Cost of Debt Calculation

Details: Accurate cost of debt calculation is essential for capital budgeting decisions, investment analysis, and determining the optimal capital structure for a company.

4. Using the Calculator

Tips: Enter coupon rate and tax rate as decimals (e.g., 0.05 for 5%, 0.25 for 25%). Both values must be between 0 and 1.

5. Frequently Asked Questions (FAQ)

Q1: Why do we multiply by (1 - Tax Rate)?
A: Interest expenses are tax-deductible, so the actual cost to the company is reduced by the tax savings.

Q2: What is a typical cost of debt range?
A: Cost of debt typically ranges from 3-8% for investment-grade companies, depending on credit rating and market conditions.

Q3: Does this formula work for all types of debt?
A: This formula is primarily for bonds. For other debt instruments, the effective interest rate should be used instead of coupon rate.

Q4: How does credit rating affect cost of debt?
A: Lower credit ratings result in higher coupon rates, which increases the cost of debt before tax benefits.

Q5: Should I use marginal or effective tax rate?
A: Use the marginal corporate tax rate, as it represents the tax rate on additional income and is most relevant for new financing decisions.