Cost of Debt

Cost of debt is the effective interest rate a company pays on its borrowed funds. It reflects the expense of financing operations through loans, bonds, or other debt instruments and is a critical component of a company's capital structure.

Formula:

Cost of Debt = (Total Interest Expense / Total Debt) × (1 – Tax Rate)

Note: If tax-deductibility applies.

Why It Matters:

  • Helps assess the affordability of debt financing.

  • Used in calculating the company’s Weighted Average Cost of Capital (WACC).

  • Aids in comparing financing options.

Example:

If a business in Dubai pays AED 150,000 annually in interest on AED 3,000,000 in debt, the cost of debt is 5% before tax.