1. What is Cost of Debt?

The cost of debt is the effective interest rate a company pays on its borrowed funds. For bonds, it's the yield to maturity adjusted for the tax shield since interest payments are tax-deductible.

2. How Does the Calculator Work?

The calculator uses the after-tax cost of debt formula:

Where:

• Yield on Bonds — The current yield to maturity of the company's bonds (in %)
• Tax Rate — The company's marginal tax rate (in %)

Explanation: The formula accounts for the tax deductibility of interest payments, which reduces the effective cost of debt for the company.

3. Importance of Cost of Debt Calculation

Details: Calculating the cost of debt is essential for determining a company's weighted average cost of capital (WACC), which is used in capital budgeting and valuation decisions.

4. Using the Calculator

Tips: Enter the bond yield and tax rate as percentages. The calculator will provide both percentage and decimal format results.

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between coupon rate and yield?
A: Coupon rate is the fixed interest rate the bond pays, while yield reflects current market conditions and the bond's price.

Q2: Should I use marginal or effective tax rate?
A: Marginal tax rate is more appropriate as it reflects the rate on the next dollar of income.

Q3: How does cost of debt affect WACC?
A: Higher cost of debt increases WACC, making investments more expensive and potentially reducing company value.

Q4: What if a company has multiple bond issues?
A: Calculate a weighted average yield based on the market values of each bond issue.

Q5: Does this apply to all types of debt?
A: The same principle applies, but different debt instruments may have different yields and terms.