Most companies that deduct the interest they pay on their income taxes, reduce the actual cost of the debt because the interest paid reduces their income taxes. Sometimes, companies present the after-tax cost of debt without acknowledging the before-tax cost. Although that may be effective for the current year, if the tax code changes, the company could lose the tax benefits and have to pay full cost without receiving the tax benefits. To calculate the before-tax cost of debt, you need to know the after-tax cost of debt and the income tax rate for the company.
1. Divide the company's effective tax rate by 100 to convert to a decimal. For example, if the company pays 29 percent in taxes, divide 29 by 100 to get 0.29.
2. Subtract the company's tax rate expressed as a decimal from 1. In this example, subtract 0.29 from 1 to get 0.71.
3. Divide the company's after-tax cost of debt by the result to calculate the company's before-tax cost of debt. In this example, if the company's after tax cost of debt equals $830,000, divide $830,000 by 0.71 to find a before-tax cost of debt of $1,169,014.08.
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