EDUCBA

EDUCBA

MENUMENU
  • Free Tutorials
  • Free Courses
  • Certification Courses
  • 250+ Courses All in One Bundle
  • Login
Home Finance Finance Resources Finance Formula Cost of Debt Formula
Secondary Sidebar
Finance Blog
  • Finance Formula
    • Skewness Formula
    • Fixed Asset Turnover Ratio Formula
    • Forecasting Formula
    • EBITDA Margin Formula
    • Accounting Ratio Formula
    • Deferred Annuity Formula
    • Capital Investment Formula
    • Ratio Analysis Formula
    • Loss Ratio Formula
    • Benefit-Cost Ratio Formula
    • Probability Distribution Formula
    • Cash Conversion Cycle Formula
    • Accrued Income
    • DCF Excel summary
    • Price to Earning Ratio Formula
    • Current Yield of Bond Formula
    • Earnings Per Share Formula
    • Manufacturing Overhead Formula
    • FCFF Formula
    • Predetermined Overhead Rate Formula
    • Times Interest Earned Ratio Formula
    • Bank Efficiency Ratio Formula
    • Capital Expenditure Formula
    • Expense Ratio Formula
    • WACC Formula
    • Activity Ratio Formula
    • Standard Error Formula
    • Forward Rate Formula
    • Gearing Formula
    • Prime Cost Formula
    • Productivity Formula
    • t-Test Formula
    • Risk Free Rate Formula
    • Tax Shield Formula
    • Sortino Ratio
    • Reserve Ratio Formula
    • Bond Formula
    • Annualized Rate of Return Formula
    • Conditional Probability Formula
    • Financing Formula
    • Future Value of an Annuity Formula
    • For Profit vs Non Profit
    • Deadweight Loss Formula
    • Inflation Formula
    • Amortized Loan Formula
    • Horizontal Analysis Formula
    • Marginal Utility Formula
    • Kurtosis Formula
    • Macaulay Duration Formula
    • Multiplier Formula
    • Modified Duration Formula
    • Operating Leverage Formula
    • Payout Ratio Formula
    • Statistics Formula
    • Sampling Error Formula
    • Trend Analysis Formula
    • Taylor Rule Formula
    • Put Call Parity Formula
    • Annual Return Formula
    • Discount Rate Formula
    • Cash Flow Formula
    • Dilution Formula
    • Attrition Formula
    • Operating Expense Formula
    • Interpolation Formula
    • Annuity Due Formula
    • Bond Yield Formula
    • Turnover Ratio Formula
    • Efficiency Formula
    • Revenue Per Employee
    • Regression Line Formula
    • Yield to Maturity
    • Pearson Correlation Coefficient Formula
    • Accounting Formula
    • Fiscal Deficit Formula
    • Tax Multiplier Formula
    • Efficiency Ratio Formula
    • Demand Elasticity Formula
    • Gross Margin Formula
    • Elasticity Formula
    • Marginal Benefit Formula
    • Depreciation Formula
    • Cost-Benefit Analysis Formula
    • Percentage Change Formula
    • Levered Beta Formula
    • Shares Outstanding Formula
    • Capital Gain Formula
    • Convexity Formula
    • Gross Income Formula
    • Net Exports Formula
    • Producer Surplus Formula
    • Accounting Rate of Return Formula
    • Net Cash Flow Formula
    • Labor Force Participation Rate Formula
    • Moving Average Formula
    • Net Worth Formula
    • Accounting Profit Formula
    • Disposable Income Formula
    • Discount Formula
    • Average Variable Cost Formula
    • Total Variable Cost Formula
    • Product Cost Formula
    • Marginal Product Formula
    • Break-Even Sales Formula
    • Return on Sales Formula
    • Cost of Goods Manufactured Formula
    • Average Fixed Cost Formula
    • Stock Turnover Ratio Formula
    • Operating Ratio Formula
    • Equity Ratio Formula
    • Net Present Value Formula
    • Aggregate Demand Formula
    • Volatility Formula
    • Marginal Product of Labor Formula
    • Z Test Statistics Formula
    • Standard Cost Formula
    • Velocity of Money Formula
    • Invested Capital Formula
    • Unlevered Beta Formula
    • Bank Reconciliation Formula
    • Portfolio Return Formula
    • Central Tendency Formula
    • Accumulated Depreciation Formula
    • Intrinsic Value Formula
    • Decile Formula
    • Vector Cross Product Formula
    • Effective Annual Rate Formula
    • CAGR Formula
    • Mode Formula
    • Arithmetic Mean Formula
    • Real GDP Formula
    • Gini Coefficient Formula
    • Expected Value Formula
    • Price Elasticity of Supply Formula
    • Net Operating Income Formula
    • Profit Percentage Formula
    • GDP Per Capita Formula
    • Altman Z Score
    • Quartile Deviation Formula
    • Return on Capital Employed Formula
    • Consumer Price Index Formula
    • Economic Profit Formula
    • Market Share Formula
    • Real Interest Rate Formula
    • Income Elasticity of Demand Formula
    • Income From Operations Formula
    • Indexation Formula
    • Sales Formula
    • Money Multiplier Formula
    • GDP Deflator Formula
    • Residual Income Formula
    • Effective Interest Rate Formula
    • Coupon Bond Formula
    • Current Account Formula
    • Total Cost Formula
    • Total Expense Ratio Formula
    • Net Sales Formula
    • Percentage Decrease Formula
    • Uncertainty Formula
    • Nominal GDP Formula
    • Effect Size Formula
    • Delta Formula
    • Cost of Sales Formula
    • Fixed Cost Formula
    • Unemployment Rate Formula
    • Present Value of Annuity Formula
    • Compounding Formula
    • Geometric Distribution Formula
    • National Income Formula
    • Accounts Receivables Turnover Formula
    • Integer Formula
    • Ending Inventory Formula
    • Owner's Equity Formula
    • Capacity Utilization Rate Formula
    • Interest Formula
    • Nominal Interest Rate Formula
    • Risk Premium Formula
    • Interest Coverage Ratio Formula
    • Gross Profit Margin Formula
    • Diluted EPS Formula
    • Return On Average Equity Formula
    • Return on Average Assets Formula
    • Working Capital Formula
    • Revenue Per Employee Ratio Formula
    • Capital Employed Formula
    • Rule of 72 Formula
    • Inventory Turnover Ratio Formula
    • Preferred Dividend Formula
    • Retention Ratio Formula
    • Present Value Factor Formula
    • Equity Multiplier Formula
    • Continuous Compounding Formula
    • Return on Assets (ROA) Formula
    • Portfolio Variance Formula
    • Weighted Average Formula
    • Net Working Capital Formula
    • Tax Equivalent Yield Formula
    • Poisson Distribution Formula
    • Current Ratio Formula
    • Debt Ratio Formula
    • Quick Ratio Formula
    • Payback Period Formula
    • Marginal Cost Formula
    • Debt to Income Ratio Formula
    • Book Value Per Share Formula
    • Asset Turnover Ratio Formula
    • Perpetuity Formula
    • Bid-Ask Spread Formula
    • Price to Book Value Formula
    • Capital Gains Yield Formula
    • Net Profit Margin Formula
    • DuPont Formula
    • Bond Pricing Formula
    • Binomial Distribution Formula
    • Sustainable Growth Rate Formula
    • Average Collection Period Formula
    • Net Income Formula
    • CAPM Formula
    • Cost of Goods Sold Formula
    • Economic Order Quantity (EOQ) Formula
    • Amortization Formula
    • Enterprise Value Formula
    • Beta Formula
    • Cost of Equity Formula
    • Rate of Return Formula
    • Revenue Formula
    • Markup Price Formula
    • Cash Flow from Operations Formula
    • Simple Interest Rate Formula
    • Consumer Surplus Formula
    • Asset to Sales Ratio Formula
    • Debt Service Coverage Ratio Formula
    • Capitalization Rate Formula
    • Cost of Debt Formula
    • Straight Line Depreciation Formula
    • Variable Costing Formula
    • Return on Invested Capital Formula
    • Profitability Index Formula
    • Expected Return Formula
    • Cost of Capital Formula
    • Price Index Formula
    • Average Total Cost Formula
    • Discount Factor Formula
    • Price Elasticity Formula
    • Profitability Ratios Formula
    • Financial Leverage Formula
    • Contribution Margin Formula
    • Time Value of Money Formula
    • Balance Sheet Formula
    • Opportunity Cost Formula
    • Current Assets Formula
    • Operating Cycle Formula
    • Operating Margin Formula
    • Bond Equivalent Yield Formula
    • Marginal Revenue Formula
    • Sales Revenue Formula
    • Net Debt Formula
    • Times Interest Earned Formula
    • Gordon Growth Model Formula
    • Required Rate of Return Formula
    • Break Even Analysis Formula
    • Inventory Formula
    • Marginal Propensity to Consume Formula
    • Debt to Asset Ratio Formula
    • Solvency Ratio Formula
    • Interest Expense Formula
    • Leverage Ratio Formula
    • Dividend Payout Ratio Formula
    • Operating Profit Margin Formula
    • PEG Ratio Formula
    • Net Interest Margin Formula
    • Return on Equity (ROE) Formula
    • Overhead Ratio Formula
    • Future Value Formula
    • Days in Inventory Formula
    • Market Capitalization Formula
    • Sharpe Ratio Formula
    • Cash Ratio Formula
    • Retained Earnings Formula
    • Average Rate of Return Formula
    • Current Liabilities Formula
    • Equity Value Formula
    • Relative Risk Reduction Formula
    • Capital Adequacy Ratio Formula
    • Debtor Days Formula
    • DPMO Formula
    • Average Formula
    • Exponential Growth Formula
    • Net Realizable Value Formula
    • Range Formula
    • Shareholders' Equity Formula
    • Sinking Fund Formula
    • Doubling Time Formula
    • Salvage Value Formula
    • Coupon Rate Formula
    • Simple Interest Formula
    • Correlation Formula
    • R - Squared Formula
    • MTBF Formula
    • Change in Net Working Capital Formula
    • Midrange Formula
    • Normal Distribution Formula
    • Mean Formula
    • Population Mean Formula
    • Median Formula
    • Central Limit Theorem Formula
    • Free Cash Flow Formula
    • Stockholder's Equity Formula
    • Acid-Test Ratio Formula
    • Percentile Rank Formula
    • Purchasing Power Parity Formula
    • Harmonic Mean Formula
    • Relative Standard Deviation Formula
    • T Distribution Formula
    • Normalization Formula
    • Operating Income Formula
    • Markup Percentage Formula
    • Relative Change Formula
    • Maturity Value Formula
    • Salary Formula
    • High Low Method
    • Income Statement Formula
    • Market to Book Ratio Formula
    • Dividends Per Share Formula
    • Daily Compound Interest Formula
    • Working Capital Turnover Ratio Formula
    • Weighted Mean Formula
    • Compounded Annual Growth Rate Formula
    • Regression Formula
    • Margin of Error Formula
    • Hypergeometric Distribution Formula
    • Standard Normal Distribution Formula
    • NOPAT Formula
    • Effective Tax Rate Formula
    • Degree of Operating Leverage Formula
    • Outliers Formula
    • Information Ratio Formula
    • Percent Error Formula
    • Hypothesis Testing Formula
    • Activity Based Costing Formula
    • Coverage Ratio Formula
    • Market Risk Premium Formula
    • Degree of Financial Leverage Formula
    • Absorption Costing Formula
    • Future Value of Annuity Due Formula
    • Internal Growth Rate Formula
    • F-Test Formula
    • Covariance Formula
    • Population Variance Formula
    • Coefficient of Determination Formula
    • Adjusted R Squared Formula
    • Compound Interest Formula
    • Gross Profit Formula
    • Accounting Equation Formula
    • Sample Size Formula
    • Sample Standard Deviation Formula
    • Quartile Formula
    • Variance Analysis Formula
    • Correlation Coefficient Formula
    • Z Score Formula
    • Variance Formula
    • Present Value Formula
    • Coefficient of Variation Formula
    • Net Asset Value Formula
    • Profit Margin Formula
    • Holding Period Return Formula
    • Capital Asset Pricing Model Formula
    • Present Value of Annuity Due Formula
    • Depreciation Expenses Formula
    • Annuity Formula
    • Taxable Income Formula
    • Profit Formula
    • Monthly Compound Interest Formula
    • Equity Formula
    • Return on Total Assets Formula
    • Alpha Formula
    • Debt to Equity Ratio Formula
    • EBITDA Formula
    • Accrued Interest Formula
    • Dividend Formula
    • Common Stock Formula
    • Mortgage Formula
    • Growth Rate Formula
    • Absolute Value Formula
  • Accounting fundamentals (700+)
  • Asset Management Tutorial (200+)
  • Banking (44+)
  • Corporate Finance Basics (373+)
  • Credit Research Fundamentals (6+)
  • Economics (88+)
  • Financial Modeling in Excel (17+)
  • Investment Banking Basics (140+)
  • Investment Banking Careers (29+)
  • Trading for dummies (69+)
  • valuation basics (27+)
  • Insurance Resources (14+)
  • Top Finance Books (7+)
Finance Blog Courses
  • Investment Banking Course
  • Investment Banking Online Course
  • Financial Modeling Certification

Cost of Debt Formula

By Madhuri ThakurMadhuri Thakur

Cost of Debt Formula

Cost of Debt Formula (Table of Contents)

  • Cost of Debt Formula
  • Examples of Cost of Debt Formula (With Excel Template)
  • Cost of Debt Formula Calculator

Cost of Debt Formula

The cost of debt is the minimum rate of return that the debt holder will accept for the risk taken. The cost of debt is the effective interest rate the company pays on its current liabilities to the creditor and debt holders. Generally, it is referred to after-tax cost of debt. The difference between the before-tax cost of debt and the after-tax cost of debt depends on the fact that interest expenses are deductible. It is an integral part of WACC, i.e., weight average cost of capital. The company’s capital cost is the sum of the Cost of debt plus the Cost of equity. And the cost of debt is 1 minus tax rate into interest expense.

The cost of debt formula is:-

Cost of Debt = Interest Expense (1 – Tax Rate)

The effective interest rate is annual interest upon total debt obligation into 100. The formula for the same is below:-

Start Your Free Investment Banking Course

Download Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

All in One Financial Analyst Bundle(250+ Courses, 40+ Projects)
Financial ModelingInvestment BankingUS GAAPCFA-Level 1 & 2
Equity ResearchM & A ModelingPrivate Equity ModelingForex Trading
Price
View Courses
250+ Online Courses | 40+ Projects | 1000+ Hours | Verifiable Certificates | Lifetime Access
4.9 (86,641 ratings)

Effective Interest Rate / Interest Expenses = (Annual Interest / Total Debt Obligation) * 100

Examples of Cost of Debt Formula (With Excel Template)

Let’s see an example to understand the cost of debt formula in a better manner.

You can download this Cost of Debt Formula Excel Template here – Cost of Debt Formula Excel Template

Cost of Debt Formula – Example #1

A company named Viz Pvt. Ltd took a loan of $200,000 from a Bank at the rate of interest of 8% to issue a company bond of $200,000. Based on the loan amount and interest rate, interest expense will be $16,000, and the tax rate is 30%.

cost of debt example 1-1

The cost of debt is calculated Using the below formula

Cost of Debt = Interest Expense (1- Tax Rate)

cost of debt example 1-2

  • Cost of Debt = $16,000(1-30%)
  • Cost of Debt = $16000(0.7)
  • Cost of Debt = $11,200

The cost of debt of the company is $11,200.

Now let’s take one more to understand the formula of interest expense and cost of debt.

Cost of Debt Formula – Example #2

Suppose a company named Arts Pvt. Ltd has taken a loan from a bank of $10 million for business expansion at a rate of interest of 8%, and the tax rate is 20%. Now we will calculate the cost of debt.

cost of debt example 2-1

Let interest is applied on principle. Assuming the interest calculation method as simple interest.

Interest Expense = Loan Amount * Rate of interest

interest calculation method as simple interest

  • Interest Expense = $10,000,000 * 8%
  • Interest Expense = $800,000

The cost of debt is calculated Using the below formula

Cost of Debt = Interest Expense (1- Tax Rate)

cost of debt example 2-3

  • Cost of Debt = $800,000 (1-20%)
  • Cost of Debt = $800,000 (0.80)
  • Cost of Debt = $640,000

Here, the cost of debt is $640,000.

The cost of debt measurement helps to find the financial condition of the company and also helps to know the risk level of the company; if the debt of the company is high, then the risk associated with the company will be high based on which investor decide on investment in the company. So, the cost of debt has a significant element of tax rate and interest expense. Once the cost of debt is calculated, one can evaluate the loan by comparing the business income that the loan has generated and the cost of debt. This cost of debt provides interest expense which later on helps in taxation that will be a tax deduction. This interest expense is used for tax saving purposes by a company as treated as business expenses.

The after-tax cost of debt formula will be as follows:-

After-Tax Cost of Debt = Cost of Debt * (1 – Tax Rate)

Now, we can see that the after-tax cost of debt is one minus tax rate into the cost of debt.

Let’s see an example to understand it better.

Cost of Debt Formula – Example #3

Suppose a company named AIM Marketing has taken a loan for business expansion of $500,000 at the rate of interest of 8%, the tax rate applicable was 30%; here, we have to calculate the after-tax cost of debt.

cost of debt example 3-1

Interest Expense is calculated using the below formula

Interest Expense = Loan Amount * Rate of interest

Interest Expense

  • Interest Expense= $500,000 * 8%
  • Interest Expense = $40,000

The cost of debt is calculated Using the below formula

Cost of Debt = Interest Expense (1- Tax Rate)

cost of debt example 3-3

  • Cost of Debt = $40,000 *(1-30%)
  • Cost of Debt = $40,000 *0.70
  • Cost of Debt = $28,000

After-Tax Cost of Debt is calculated Using the below formula

After-Tax Cost of Debt = Cost of Debt * (1 – Tax Rate)

cost of debt example 3-4

  • After-tax cost of debt = $28,000 * (1-30%)
  • After-Tax Cost of Debt = $28,000* (0.70)
  • After-Tax Cost of Debt = $19,600

Now, we got an after-tax cost of debt which is $19,600.

The after-tax cost of debt is high as income tax paid by the company will be low as the company has a loan on it, and the interesting part paid by the company will be deducted from taxable income. Hence, the cost of debt is crucial as it gives a chance to a company to save its tax. When a company borrows money for the issuance of a bond, it is kept in mind that the rate of interest is shown below as the company has to give a fixed rate of interest to an investor who has invested in their company bonds.

Now, let’s see a practical example to calculate the cost of debt formula.

Cost of Debt Formula – Example #4

A company named S&M Pvt. Ltd has taken a loan of $50,000 from a financial institution for five years at a rate of interest of 8%; the tax rate applicable is 30%. Now, we will see amortization to calculate the cost of debt.

cost of debt example 4-1

Amortization schedule of one year of the loan.

Amortization schedule

Here, we can see that interest paid by a company in one year is:-

interest paid by a company

  • Interest Expenses = 333 + 329 + 324 + 320 + 315 + 310 + 306 + 301 + 296 + 291 + 287 + 282
  • Interest Expenses = $3,694

The cost of debt is calculated using the formula

Cost of Debt = Interest Expense (1- Tax Rate)

cost of debt example 4-4

  • Cost of Debt = $3,694 * (1-30%)
  • Cost of Debt = $2,586

The cost of debt is lower as a principal component of a loan keeps on decreasing; if the loan amount has been used wisely and can generate a net income of more than $2,586, then taking a loan is beneficial.

Relevance and Uses of Cost of Debt Formula

There are multiple uses of the cost of debt formula; they are as follows:-

  • Cost of debt help to save taxes.
  • It helps to calculate the risk associated with the company.
  • It helps one calculate the net income a company generates by using loan amounts.
  • The cost of debt formula is a component of WACC, i.e., Weighted average Cost of capital.
  • To know a company’s actual financial position, one can also calculate the after-tax debt cost.

Ways to Low Cost of Debt

There are many ways to reduce the low cost of debt; they are as follows:-

  • Get Cheaper Loan

A cheaper loan means to get a loan at a lower rate of interest which can be done by creating a good credit score by repaying loans on time, offering collaterals, negotiating, etc.

  • Refinancing Loan

First, one needs to start a loan with a rate of interest he is eligible for; then, when the business starts growing, he can refinance the loan at a lower rate after some months of the loan.

  • Optimize Business Growth

With an increase in income of the business, one can avail more debt as he can afford it. The cost of debt is compared with income generated by loan amount, so increasing business income can reduce the cost of debt.

Cosdebt Debt Formula Calculator

You can use the following Cost of Debt Calculator

Interest Expense
Tax Rate
Cost of Debt Formula =
 

Cost of Debt Formula = Interest Expense x (1 - Tax Rate)
=0 x (1 - 0) = 0

Conclusion

It is a tool that helps one know whether that loan is profitable for business as we can compare the cost of debt with income generated by loan amount in business. The loan can be taken for multiple reasons, from issuing bonds to buying prime machinery to generate revenue and grow business. It also helps to know the cost of capital of a company. It helps to know the actual cost of debt, and debt helps to justify the cost of debt in the business.

Recommended Articles

This has been a guide to a Cost of Debt formula. Here we discuss How to Calculate the Cost of Debt along with practical examples. We also provide you with the Cost of Debt Calculator with a downloadable excel template. You may also look at the following articles to learn more –

  1. Amortization Formula
  2. Guide and Formula for EOQ
  3. Calculator for CAPM Formula
  4. Examples of Diluted EPS Formula
Popular Course in this category
All in One Financial Analyst Bundle- 250+ Courses, 40+ Projects
  250+ Online Courses |  1000+ Hours |  Verifiable Certificates |  Lifetime Access
4.9
Price

View Course

Related Courses

Investment Banking Course (123 Courses, 25+ Projects)4.9
Investment Banking Course (123 Courses, 25+ Projects)4.8
Financial Modeling Course (7 Courses, 14 Projects)4.7
4 Shares
Share
Tweet
Share
Primary Sidebar
Footer
About Us
  • Blog
  • Who is EDUCBA?
  • Sign Up
  • Live Classes
  • Corporate Training
  • Certificate from Top Institutions
  • Contact Us
  • Verifiable Certificate
  • Reviews
  • Terms and Conditions
  • Privacy Policy
  •  
Apps
  • iPhone & iPad
  • Android
Resources
  • Free Courses
  • Investment Banking Jobs Offer
  • Finance Formula
  • All Tutorials
Certification Courses
  • All Courses
  • Financial Analyst All in One Bundle
  • Investment Banking Training
  • Financial Modeling Course
  • Equity Research Course
  • Private Equity Training Course
  • Business Valuation Course
  • Mergers and Acquisitions Course

ISO 10004:2018 & ISO 9001:2015 Certified

© 2022 - EDUCBA. ALL RIGHTS RESERVED. THE CERTIFICATION NAMES ARE THE TRADEMARKS OF THEIR RESPECTIVE OWNERS.

EDUCBA
Free Financial Modeling Course

3 Statement Model Creation, Revenue Forecasting, Supporting Schedule Building, & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA Login

Forgot Password?

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA
Free Investment Banking Course

Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

Let’s Get Started

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA

Download Cost of Debt Formula Excel Template

EDUCBA

डाउनलोड Cost of Debt Formula Excel Template

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Loading . . .
Quiz
Question:

Answer:

Quiz Result
Total QuestionsCorrect AnswersWrong AnswersPercentage

Explore 1000+ varieties of Mock tests View more