Cost of debt

The cost of debt the required return by an lender for a borrowed amount. For the company, it can be seen as a cost as the interest paid on the debt is categorized as an expense. It is usually noted by $K_{d}$.

The gross Cost of Debt can be computed as the total yearly amount of interest paid on the total amount borrowed.

As interests are deductible from the tax form, the company usually take only in account the after-tax cost of debt:

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

The cost of debt is one of the input for the Weighted Cost of Capital which gives the cost of the capital sources, taking into account origin of it.

Estimation

Recalling that the value of a bond is equal to the present value of the coupons and the face value at $t=N$:

$PV\,=\,A\cdot {\frac {1-{\frac {1}{\left(1+K_{d}\right)^{n}}}}{K_{d}}}+{\frac {FV}{(1+K_{d})^{N}}}$.

It could be possible to solve this equation for $K_{d}$ by a numerical method or an iterative trial and error procedure.

As noticed above, we have to take in account the tax deductibility of interest expenses.

After Tax $K_{d}$ = Before Tax $K_{d}$ *( 1 - Tax rate)

See also

Weighted Cost of Capital

Cost of Equity