After-tax cost of debt
Principles of Finance glossary · Cost of Capital & Capital Structure
Definition
r_d · (1 - T), where r_d is the pre-tax cost of debt (typically the yield-to-maturity on the firm's marginal long-term debt) and T is the marginal tax rate; the debt cost used in WACC because interest is tax-deductible.
After-tax cost of debt in plain English
When a company borrows money, it pays interest — but here's a bonus: in most countries, interest is tax-deductible, meaning the company subtracts it before figuring its tax bill, which shrinks the taxes it owes. So the borrowing doesn't really cost the full sticker rate; the government effectively refunds part of it. The formula r_d · (1 - T) captures this: take the interest rate r_d and multiply by the fraction that survives after the tax break, where T is the tax rate. For example, a 10% loan for a company taxed at 20% really only costs 10% · (1 - 0.20) = 8% — like a coupon that quietly knocks a slice off every interest payment.
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