How to Calculate the Pre-tax Cost of a Debt

Pre-tax cost of debt is important for companies trying to raise capital.

Cost of debt is what it costs a company to maintain debt. The amount of debt is normally calculated as the after-tax cost of debt because interest on debt is normally tax-deductible. The general formula for after-tax cost of debt then is pretax cost of debt x (100 percent - tax rate). The company will retain the non-taxed portion of the debt while the government taxes the taxable portion of the debt. For example, a company borrows $10,000 at a rate of 8 percent interest. The pre-tax cost of debt is then 8 percent.

Instructions

1. Determine the company's tax rate and after-tax cost of debt. For example, a company's tax rate is 35 percent, and its after-tax cost of debt is 10 percent.

2. Write out the formula for after-tax cost of debt. In our example, 10 percent = pre-tax cost of debt x (100 percent - 35 percent).

3. Solve for the pre-tax cost of debt. In our example, pre-tax cost of debt equals 15.38462 percent.

References

• Understanding Finance: Cost of Debt
• Expectations Investing: How Do You Calculate A Company's Cost of Capital