Calculate the Weighted Average Cost of Debt

Determine the effective after-tax interest rate your business pays across all debt obligations.

Debt Obligations

Debt Source #1

Debt Source #2

Debt Source #3

Debt Source #4

What is the Weighted Average Cost of Debt?

To calculate the weighted average cost of debt is to determine the effective rate a company pays on its borrowed funds, adjusted for the proportion of each debt relative to the total debt load. Unlike a simple average, a weighted average accounts for the fact that a large loan at a low interest rate has a bigger impact on your finances than a small loan at a high rate.

This metric is a critical component of the Weighted Average Cost of Capital (WACC). Financial analysts, CFOs, and investors use it to assess the health of a company's balance sheet and to determine the hurdle rate for new investment projects. Furthermore, because interest payments are typically tax-deductible, the "cost" is usually calculated on an after-tax basis, providing a more accurate picture of the net cash outflow required to service debt.

Common misconceptions include simply averaging the interest rates of all loans without considering the loan amounts, or forgetting to apply the tax shield, which significantly lowers the effective cost of borrowing.

Weighted Average Cost of Debt Formula

The mathematical approach to calculate the weighted average cost of debt involves two main steps: determining the pre-tax weighted average and then adjusting for taxes.

Step 1: Pre-Tax Weighted Average
$$ \text{Pre-Tax Rate} = \frac{\sum (\text{Principal}_i \times \text{Interest Rate}_i)}{\text{Total Debt}} $$

Step 2: After-Tax Adjustment
$$ \text{After-Tax Cost} = \text{Pre-Tax Rate} \times (1 – \text{Tax Rate}) $$

Table 2: Variables used in the cost of debt calculation formula.

Variable	Meaning	Unit	Typical Range
Principal_i	The outstanding balance of a specific debt	Currency ($)	$0 – Billions
Interest Rate_i	The nominal annual rate for that specific debt	Percentage (%)	2% – 15%
Total Debt	Sum of all debt principals	Currency ($)	Variable
Tax Rate	Corporate effective tax rate	Percentage (%)	15% – 30%

Practical Examples

Example 1: Small Manufacturing Business

A manufacturing company has two primary loans. They want to calculate the weighted average cost of debt to see if they should refinance.

• Loan A: $500,000 at 6% interest (Bank Loan)
• Loan B: $100,000 at 9% interest (Equipment Lease)
• Tax Rate: 21%

Total Debt: $600,000
Weighted Interest: (($500k × 6%) + ($100k × 9%)) / $600k = ($30,000 + $9,000) / $600k = 6.5%
After-Tax Cost: 6.5% × (1 – 0.21) = 5.135%

Interpretation: Even though they have a high-interest lease, the large low-interest bank loan keeps their overall cost of debt relatively low.

Example 2: Corporate Bond Issuance

A corporation has issued bonds and holds a commercial paper.

• Bonds: $10,000,000 at 4.5%
• Commercial Paper: $2,000,000 at 3.0%
• Tax Rate: 25%

Total Debt: $12,000,000
Pre-Tax Average: 4.25%
After-Tax Cost: 4.25% × 0.75 = 3.19%

Interpretation: The company effectively pays only 3.19% on its capital due to the tax deductibility of interest.

How to Use This Cost of Debt Calculator

1. Enter Tax Rate: Input your company's effective corporate tax rate. If unknown, use the standard statutory rate (e.g., 21% in the US).
2. Input Debt Sources: For each loan, bond, or credit line, enter the current principal balance and the annual interest rate.
3. Review Results: The calculator instantly updates. The primary result is your After-Tax Weighted Average Cost of Debt.
4. Analyze the Table: Check the breakdown table to see which loan contributes most to your interest expense.
5. Copy Data: Use the "Copy Results" button to paste the data into your reports or spreadsheets.

Use this figure as the $r_d$ component when calculating WACC (Weighted Average Cost of Capital).

Key Factors That Affect Results

Several variables can significantly impact your calculation:

1. Interest Rate Environment: Central bank policies directly influence variable-rate loans. As market rates rise, your weighted average cost increases if you hold floating-rate debt.
2. Credit Rating: A lower credit score implies higher risk for lenders, leading to higher interest rates on new debt, dragging up your weighted average.
3. Tax Rate Changes: A higher corporate tax rate actually lowers your after-tax cost of debt because the tax shield (deduction) becomes more valuable.
4. Debt Maturity Structure: Short-term debt often has lower rates than long-term debt. A portfolio heavy in short-term debt may show a lower cost now but carries refinancing risk.
5. Fees and Amortization: While this calculator focuses on nominal rates, true effective cost should technically include amortization of issuance fees, though often omitted for simplicity.
6. Debt Weighting: Taking on a massive new loan, even at a slightly lower rate, changes the weights significantly and will pull the average closer to that new loan's rate.

Frequently Asked Questions (FAQ)

Why do we multiply by (1 – Tax Rate)?

Interest expenses are tax-deductible. This means every dollar paid in interest reduces taxable income, saving you money on taxes. The formula adjusts for these savings to show the true "net" cost.

Should I use book value or market value of debt?

For strict academic WACC calculations, market value is preferred. However, for internal corporate planning and bank covenants, book value (principal amount) is commonly used and easier to find.

What if I have a 0% interest loan?

Include it! A 0% loan reduces your weighted average significantly. Enter it with 0% interest to see the benefit.

Does this include preferred stock?

No. Preferred stock is calculated separately in the WACC formula because its dividends are typically not tax-deductible.

How does this relate to WACC?

This result is the $r_d(1-t)$ portion of the WACC formula. You combine this with the Cost of Equity ($r_e$) to get the total WACC.

Can I calculate this for personal debt?

Yes, but set the Tax Rate to 0% unless your interest is tax-deductible (like a mortgage). For personal credit cards and auto loans, the tax shield usually does not apply.

What is a good weighted average cost of debt?

It depends on the industry and economic climate. Generally, a rate close to the risk-free rate plus a small spread (2-4%) is considered healthy for investment-grade companies.

What if my debt has a variable rate?

Use the current effective rate for a snapshot calculation, or an estimated average rate for long-term forecasting.