There are three main steps to calculate the after-tax cost of debt.
Step 1: Calculate the before-tax cost of debt
Your pre-tax cost of debt is the sum of your interest payments without adjusting for tax savings. To calculate the cost of debt, you’ll need to add the interest payments on all small business financing tools.
Let’s say our business has several lines of credit with an average interest rate of 6.9%. If we want to represent this as a decimal, we simply divide the interest rate by 100.
Step 2: Calculate the marginal tax rate
You’ll need to know your pre-tax and net income to calculate your marginal tax rate. Here’s how that formula looks:
marginal corporate tax rate = 1 – (net income / pre-tax income)
Let’s say our business has $660,000 pre-tax and $525,000 net income. The calculation looks like this:
marginal corporate tax rate = 1 – ($525,000 / $660,000)
0.20 = 1 – (0.80)
If we want to represent this as a percentage, we can multiply our result by 100 to get a marginal tax rate of 20%.
Step 3: Calculate the after-tax cost of debt
Now that we’ve done all that leg work, we can plug our values into the after-tax cost of debt formula.
after-tax cost of debt = before-tax cost of debt * (1 – marginal corporate tax rate)
5.5% = 6.9% (1 – 20%)
Let’s look at the same equation but use decimals.
0.055 = 0.069 (1 – 0.2)
We can turn our result back into a percentage by multiplying it by 100, giving us an after-tax interest rate of 5.5%.