Your Ask Joey ™ Answer

How a decline in tax rates impacts the after-tax cost of debt?

This page answers the question of how a decrease in tax rates impacts the after-tax cost of debt and the overall weighted average cost of capital for a company. As an example, let’s say that a company has a loan with an interest rate of 5%, which is their cost of debt. We can also say that the current tax rate is 30%, but tax rates are expected to decline to 25%.

We can calculate the after-tax cost of debt by multiplying the cost of debt by “1 minus the tax-rate”. We do this because interest expense is tax deductible, so we need to take into account the decrease in taxable income from interest payments a company makes on their debt.

So looking at our example below, we can see that when the tax rates decrease, this increases the after-tax cost of debt. This really just means that the benefit received from interest payments being tax deductible is less impactful on a lower tax rate.

If the after-tax cost of debt increases, then the overall weighted average cost of capital will increase as well. The overall impact to a company really depends on the ratio of debt in their capital structure. If debt is a small piece of the capital structure, the impact to the weighted average cost of capital will be minimal.


Back To All Questions

You might also be interested in...

  • Three Reasons to Become an Accountant

    If you’re someone who is intrigued by numbers, enjoys problem-solving and wants to help others, then accounting might be the perfect career for you. While some people may be put off by its unalluring reputation, accounting is an excellent career choice that has many benefits. In this article, we look at three of the reasons...

  • Qualified Retirement Planning: Tax Advantages & Disadvantages

    Home Advantages and Disadvantages of Tax-Free and Deferred-Tax Retirement Plans What are “qualified retirement plans” and how can they be effective for tax planning? Well, there are plenty of tax savings advantages to individuals contributing to tax-free retirement accounts, as well as tax-deferred retirement accounts. However, this doesn’t necessarily mean that there are no disadvantages...

  • CPA Evolution Survival Guide

    Download Your eBook by selecting the download icon in the top right-hand corner