Find the effective cost of borrowing after accounting for the tax deductibility of interest payments.
Interest payments on business debt are tax-deductible, reducing the effective cost. At a 21% corporate tax rate, a 6.5% loan effectively costs only 5.135% after tax. This "tax shield" is one reason companies use debt financing.
The after-tax cost of debt is a key input in Weighted Average Cost of Capital (WACC):
WACC = (E/V × Re) + (D/V × Rd × (1−T))
Where Rd × (1−T) is the after-tax cost of debt.
The federal corporate tax rate is 21% (since the Tax Cuts and Jobs Act of 2017). State taxes add 0-12% depending on the state, making the combined effective rate typically 24-28%.