The after-tax cost of debt is the effective interest rate that you would earn on a loan. It takes into account tax, inflation, and other factors to give you an actual sense of how much money you’d make off a loan, especially if it were tax-deductible. You can use this information to determine whether or not it makes sense for your company to take on debt, or if it’s better off investing in something else like shares or property.
Definition of After-tax Cost of Debt
The after-tax cost of debt is the weighted average cost of capital for a company and its projects. It is calculated by taking the interest rate paid on debt, subtracting the tax rate, and then subtracting any tax savings from interest deductibility. Because it accounts for both the cost of financing and taxes, this metric can be used as a tool to evaluate projects that require borrowing money from external sources.
The calculation takes into account both sides of an equation: how much interest you pay out and how much you earn on your cash reserves (your “profitability”).
How calculate after-tax cost
The after-tax cost of debt is the interest rate that a company must pay on its debt to keep its net present value (NPV) the same as if it had no debt. That’s because when you borrow money, you have to pay tax on the income that you generate using that borrowed capital. If you didn’t have to pay taxes, then borrowing would be cheaper than raising equity.
You can easily calculate it using our calculator right on this page!
Uses of after-tax cost
You can use the after-tax cost of debt to compare the cost of debt to another source of financings, such as equity or another form of debt. This is often used when analyzing a company’s capital structure.
History of after-tax cost
The idea of the after-tax cost of debt has been around for a long time. In fact, it was first introduced in the late 1960s by Robert McDonald, an expert on financing and corporate finance. He developed the concept to help investors make better decisions about whether they should use debt or equity financing.
The after-tax cost of debt is also known as the “operating” or “economic” cost of capital because it estimates a company’s cost of capital after taxes have been paid on interest expenses. This allows investors to compare different financing options based on their tax rates and provides companies with data that can be used to determine if they’re getting enough out of their investments in terms of interest payments and net income generated by using debt instead of equity.
