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Learn How to Calculate Cost of Debt | Cash Flow Forecasting and Discount Rate Fundamentals
Mastering Discounted Cash Flow Analysis with Excel
course content

Course Content

Mastering Discounted Cash Flow Analysis with Excel

Mastering Discounted Cash Flow Analysis with Excel

1. Introduction to Business Valuation
2. Understanding Discounted Cash Flow (DCF) Analysis
3. Cash Flow Forecasting and Discount Rate Fundamentals
4. WACC, Terminal Value & Sensitivity Analysis
5. Building a DCF Valuation Model in Excel
6. Practical DCF Case Study – Company Valuation in Action

book
How to Calculate Cost of Debt

Debt is one of the primary ways companies finance their operationsβ€”through bank loans, bonds, lines of credit, or leases. Each of these comes with a price tag: interest. This interest is what we refer to as the cost of debt.

But there's a twist: interest is usually tax-deductible.

In most tax systems, interest payments reduce a company's taxable income. This creates a tax shield, meaning the true cost of debt is less than the nominal interest rate.

That's why we use the after-tax cost of debt in valuation.

Here's how it's calculated:

After-TaxΒ CostΒ ofΒ Debt=InterestΒ RateΓ—(1βˆ’TaxΒ Rate)\text{After-Tax Cost of Debt} = \text{Interest Rate} \times (1 - \text{Tax Rate})

This reflects the net cost to the company after considering tax savings. For example, if a firm pays 6% interest and faces a 25% tax rate:

CostΒ ofΒ Debt=6%Γ—(1βˆ’0.25)=4.5%\text{Cost of Debt} = 6\% \times (1 - 0.25) = 4.5\%

You might determine the interest rate from:

  • The company's actual loan agreements;

  • The yield to maturity on corporate bonds;

  • An average of current market rates for similar firms.

The after-tax cost of debt is a crucial component in valuation and capital structure analysis. It rewards firms that finance strategically and leverage the tax system to reduce capital costs.

Everything was clear?

How can we improve it?

Thanks for your feedback!

SectionΒ 3. ChapterΒ 3

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course content

Course Content

Mastering Discounted Cash Flow Analysis with Excel

Mastering Discounted Cash Flow Analysis with Excel

1. Introduction to Business Valuation
2. Understanding Discounted Cash Flow (DCF) Analysis
3. Cash Flow Forecasting and Discount Rate Fundamentals
4. WACC, Terminal Value & Sensitivity Analysis
5. Building a DCF Valuation Model in Excel
6. Practical DCF Case Study – Company Valuation in Action

book
How to Calculate Cost of Debt

Debt is one of the primary ways companies finance their operationsβ€”through bank loans, bonds, lines of credit, or leases. Each of these comes with a price tag: interest. This interest is what we refer to as the cost of debt.

But there's a twist: interest is usually tax-deductible.

In most tax systems, interest payments reduce a company's taxable income. This creates a tax shield, meaning the true cost of debt is less than the nominal interest rate.

That's why we use the after-tax cost of debt in valuation.

Here's how it's calculated:

After-TaxΒ CostΒ ofΒ Debt=InterestΒ RateΓ—(1βˆ’TaxΒ Rate)\text{After-Tax Cost of Debt} = \text{Interest Rate} \times (1 - \text{Tax Rate})

This reflects the net cost to the company after considering tax savings. For example, if a firm pays 6% interest and faces a 25% tax rate:

CostΒ ofΒ Debt=6%Γ—(1βˆ’0.25)=4.5%\text{Cost of Debt} = 6\% \times (1 - 0.25) = 4.5\%

You might determine the interest rate from:

  • The company's actual loan agreements;

  • The yield to maturity on corporate bonds;

  • An average of current market rates for similar firms.

The after-tax cost of debt is a crucial component in valuation and capital structure analysis. It rewards firms that finance strategically and leverage the tax system to reduce capital costs.

Everything was clear?

How can we improve it?

Thanks for your feedback!

SectionΒ 3. ChapterΒ 3
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