Financial Glossary
After-Tax Cost of Debt
After-tax cost of debt is the real cost of borrowing after accounting for the fact that interest expense is generally tax-deductible. You take the pre-tax interest rate and reduce it by the tax shield, which is the rate multiplied by one minus the company's marginal tax rate. The result is lower than the stated rate because deductible interest reduces taxable income.
Problem & Application
Owner-operators comparing a loan to an equity raise need the after-tax figure because the deductibility of interest can make debt meaningfully cheaper than the headline rate suggests. It is also a core input in weighted average cost of capital, so a wrong tax assumption ripples into valuation and capital-budgeting decisions. Operators in pass-through entities should confirm which entity-level rate applies before plugging in a number, since the deduction may flow to owners rather than the business.
In Short
Always evaluate financing decisions on an after-tax basis, since the interest deduction can change which option is genuinely cheaper.