There are two significant sources of financing: debt financing and equity financing. Any company needs to borrow from various sources to finance its operations. The company needs to pay interest on that debt. This effective interest rate is known as the cost of debt. Most of the time, we evaluate the cost of debt after tax. However, we will show you 3 quick methods to calculate before tax cost of debt in Excel. The after-tax cost of debt is tax deductible, but the before tax cost of debt is not.
How to Calculate Before Tax Cost of Debt in Excel: 3 Handy Approaches
We will show you the methods in 3 different data sets. Here is a quick view of one of the solutions.
1. Calculating Before Tax Cost of Debt by Applying General Formula
We will use a simple formula for the first method. If we divide the total interest by the total debt, then we will find the before tax cost of debt.
Steps:
- To begin with, type the following data. We know the first 2 values.
- Total Interest → $6,500.
- Total Debt → $38,000.
- Cost of Debt → We will calculate this by dividing $6,500 by $38,000.
- Next, type the following formula in cell C6.
=C4/C5
- Then, press ENTER.
- Lastly, change the Number Format to Percentage.
Read More: How to Use Debt to Equity Ratio Formula in Excel
2. Calculating Before Tax Cost from After Tax Cost of Debt
In this section, we know the after-tax cost of debt and will find the amount of before tax cost of debt using that information. If we divide the “After Tax Cost of Debt” by the (1-Company Tax Rate), then we can find the “Before Tax Cost of Debt”.
Steps:
- Firstly, type the following things:
- Cost of Debt After Tax → $135,640.
- Company Tax Rate (CTR) → 35%.
- 1 – CTR → We will find this by deducting 1 from 35%.
- Cost of Debt Before Tax → This is our goal. We will see this value by dividing $135,640 by 65% (from 1-35%).
- Secondly, type the following formula in cell C6 and press ENTER.
=1-C5
- Thirdly, type another formula in cell C7 to find the cost of debt before tax.
=C4/C6
- Lastly, press ENTER and we will find the cost of debt before applying any taxes.
3. Using RATE Function to Calculate Before Tax Cost of Debt
For the last method, we will use the RATE function to find the half-yearly interest rate and use that value to calculate the before tax cost of debt.
Steps:
- First, type these values:
- Par Value → $1,000.
- Current Market Price → $1,050.
- Coupon Rate → 8.15%.
- Terms (Years) → 10.
- Half Yearly Interest Rate → We will find this value by dividing the Coupon Rate by the Par Value.
- Half Yearly Interest Rate → Using the RATE function, we will find this value.
- Before Tax Cost of Debt → Our aim is to find this value.
- Afterward, type this formula in cell C8 and press ENTER. Here, we have divided by 2 as the interest is semi-annually compounded.
=C6/2*C4
- Then, type another formula in cell C9.
=RATE(C7*2,C8,-C5,C4)
- After that, press ENTER.
Formula Breakdown
- Firstly, we have multiplied the terms by 2 as the interest rate is semi-annually compounded.
- Then, we input the half-yearly interest expense.
- After that, the current market price is entered as a present value. Moreover, this is a negative value because we are considering this as a cash outflow.
- Finally, we insert the par value as the future value.
- Lastly, type the following formula in cell C10 and press ENTER to find our desired value.
=C9*2
Practice Section
We have added a practice dataset for each method in the Excel file. Therefore, you can follow along with our methods easily.
Download Practice Workbook
Conclusion
We have shown you 3 quick ways to calculate before tax cost of debt in Excel. If you face any problems regarding these methods or have any feedback for me, feel free to comment below. Thanks for reading, keep excelling!
