Cost of debt

Cost of debt is the effective interest rate a firm pays on its borrowings, measured after tax because interest is tax-deductible: Kd × (1 − t). It is the debt component in the WACC formula.

ByHoang TruongUpdated June 30, 2026

FrameworkWACC

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A firm's bonds yield 6.0% to maturity and the corporate tax rate is 25%. Because interest is tax-deductible, the government effectively absorbs 25% of the interest bill, so only 0.75 of the pre-tax rate is actually borne by the firm. After-tax cost of debt = 6.0% × (1 − 0.25) = 4.5%, the figure that belongs in the WACC calculation, not the 6.0% market yield itself.

Where it fits

TopicCost of Capital & WACCCoreSubjectCorporate FinanceCore

The formula

LaTeX

R_d^{\text{post-tax}} = R_d \times (1 - T)

Variables

$R_{d}$: Pre-tax cost of debt (yield to maturity on bonds) (decimal)
$T$: Corporate tax rate (decimal)

Interest is tax-deductible, so the government absorbs a share of the interest bill equal to T.

Check yourself

PracticeCORE

A company's bonds have a yield to maturity of 7.5%. The corporate tax rate is 30%. What is the after-tax cost of debt to use in the WACC calculation?

Select an answer to check your understanding.