Cost of debt is the effective rate that a company pays on its current debt. This can be measured in either before or after tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. This is one part of the company's capital structure, which also includes the cost of equity. To get the after-tax rate, you multiply the before tax rate by one minus the
. marginal tax rate (before-tax rate x (1-marginal tax)). If a company's only debt were a single bond in which it paid 5%, the before tax cost of debt would simply be 5%. If, however, the company's marginal tax rate were 40%, the company's after tax cost of debt would be only 3% (5% x (1-40%)).
