# Cost of debt

Last updated: 16.03.2016

Cost of debt is:

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

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

Kd = (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!).

## Example no.1

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

Kd = ((8% * 10 000) / 10 000)) * (1 – 0,15) = 0,08 * 0,85 = 0,068 (6,8%)

## Example no.2

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

Kd = ((8% * 10 000) / (10 000*1,05)) * (1 – 0,15) = 0,07619 * 0,85 = 0,065 (6,5%)

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

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

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