Cost of Debt:
It is the main technique of cost of capital in finance and financial management. The Cost of debt is computed on the debt, bonds, loan or debentures via multiplying interest rate with certain amount of debt. When rate is not given, then you can too compute cost of debt rate. This rate is termed as Kd.
Cost of Debt without Any Adjustment (Kd) = Amount of Interest / Amount of Loan X 100
In situation, company issues the bonds or debenture on premium, at that time; we can compute cost of debt by the formula shown below:
Cost of Debt (Kd) = Interest amount/ (Amount of debenture + Amount of premium) X 100
In situation, company issues the bonds or debenture on discount, at that time; we can compute cost of debt by the formula shown below:
Cost of Debt (Kd) = Interest Amount/ (Amount of Debenture – Amount of Discount) X 100
When we have to compare cost of debt with the cost of equity, then we have to compute it after adjustment of tax since interest is deducted from gain before tax although dividend is removed from gain after tax.
Cost of Debt = Amount of Interest (1 – Tax Rate) / Amount of Loan X 100
For illustration, interest rate of company is 10% before tax; compute cost of debt after tax of 30%
Cost of Debt = 10 % X (1-30%) = 7%
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