Cost of debt

(Kd(1-t)).

The component of a firm's Weighted average cost of capital which relates to the servicing of the firm's providers of debt capital. The calculation of the current market cost of debt is based on the Market Yield to maturity of any debt currently in issue. This will normally be different from the interest rate on the debt, which is not the relevant measure for investment decision making purposes.

The calculation should also take account of related corporate tax relief on the debt servicing costs. Hence the '(1-t)' term in Kd(1-t).

In a simple example, where the relevant cost of debt is 5% per annum before tax relief, all debt servicing costs are fully tax relieved at 28%, and assuming no timing differences between paying the debt servicing costs and enjoying the related tax relief, Kd(1-t) = 5% x (1-0.28) = 3.6%.

More strictly, the tax relief should be factored into the net cost of debt calculation by taking account of any timing differences between the debt servicing cash outflows and the related tax savings.

Cost of debt is often denoted more simply as 'Kd'. However this is not best practice, because it may be ambiguous whether the 'Kd' figure is stated before or after the related tax relief.

See also

• Cost of equity
• Weighted average cost of capital
• Yield to maturity