5 2016-03-16 Febmat.com

# Cost of debt

**Cost of irredeemable (perpetual) debt**** – debt without any fixed date of repayment**

## Example no.1

## Example no.2

**Cost of redeemable debt**** – debt that will be repaid during specific period of time**

Last updated: 16.03.2016

**Cost of debt is:**

**the return required by the debtholders****the component of cost of capital (WACC)**

**Cost of debt is the interest paid reduced by the tax deduction on the interest. **

**Cost of debt is calculated separately for each type of debt: **

- irredeemable debt
- redeemable debt

**K _{d} = (annual interest / debt value) * (1 – tax rate)**

If the debt is issued **at** **discount or premium **(i.e. not at par value), the denominator is reduced / increased by the amount of the discount/premium (not the basis for calculation of annual interest!).

*The company issues 8% irredeemable debentures to raise € 10 000. The rate of taxation is 15%. *

*K _{d} = ((8% * 10 000) / 10 000)) * (1 – 0,15) = 0,08 * 0,85 = 0,068 (6,8%)*

*The company issues 8% irredeemable debentures to raise € 10 000 at 5% premium. The rate of taxation is 15%. *

*K _{d} = ((8% * 10 000) / (10 000*1,05)) * (1 – 0,15) = 0,07619 * 0,85 = 0,065 (6,5%)*

Cost of redeemable debt is calculated the same way as internal rate of return (IRR). Therefore, relevant cash-flows for each year (or other period) must be prepared and these cash-flows are discounted to present value.

**The calculation formula is the same as with IRR and the relevant cash-flows include:**

- market value of the debt instrument issued
- repayments of principal and interest payments
- possibly also transaction costs