After-tax cost of debt means calculating the rate of interest after deducting tax rate from total interest rate. Actually we calculate cost of debt before the tax because interest is our operating charges and it is deducted from our total revenue for tax purpose. So, there is no need to calculate after-tax cost of debt. But some good finance managers recommend calculating after-tax cost of debt because with this, we can estimate our total tax saving, if we get money through debt instead of shares or stock.

For example ABC Company has issued 10000 shares and debentures with the price of \$ 10 each. Cost of debt is 10% and cost of equity share capital is also 10%. Suppose, corporate income tax rate is 25%. After tax cost of debt will be

= 10/100 X 75/100 = 7.5%

But in case cost of equity share capital, we have estimated (not fixed) to pay 10%. By this way, we save 2.5% tax money if we get loan through debenture. This is \$ 2500 which we can reinvest in good project. Otherwise, our \$ 2500 will go to Govt. account. So, to calculate this rate and on this rate we can estimate our tax saving.
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