{"id":31375,"date":"2025-05-07T10:22:50","date_gmt":"2025-05-07T15:22:50","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/?post_type=biws_kb&#038;p=31375"},"modified":"2025-12-17T00:17:31","modified_gmt":"2025-12-17T05:17:31","slug":"cost-of-debt","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/valuation\/cost-of-debt\/","title":{"rendered":"The Cost of Debt in Valuations, Credit, and Real Life"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">The Cost of Debt in Valuations, Credit, and Real Life<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/cost-of-debt\/#Interpreting_the_Cost_of_Debt_Clarifications\">Interpreting the Cost of Debt: Clarifications<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/cost-of-debt\/#Calculating_the_Cost_of_Debt_in_Real_Life_Complexities_and_Missing_Information\">Calculating the Cost of Debt in Real Life: Complexities and Missing Information<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/cost-of-debt\/#Calculating_the_Cost_of_Debt_in_Real_Life_Multiple_Issuances\">Calculating the Cost of Debt in Real Life: Multiple Issuances<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/cost-of-debt\/#Calculating_the_Cost_of_Debt_in_Real_Life_No_Fair_Values_Disclosed\">Calculating the Cost of Debt in Real Life: No Fair Values Disclosed<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/cost-of-debt\/#Calculating_the_Cost_of_Debt_in_Real_Life_No_Debt\">Calculating the Cost of Debt in Real Life: No Debt<\/a><\/li><\/ul><\/nav><\/div>\n\n<blockquote><p><strong>Cost of Debt Definition:<\/strong> The Cost of Debt in corporate finance represents the effective rate a company would pay if it issued <em>additional Debt<\/em> today; most of this cost is the Interest Expense on the Debt, but some may also correspond to discounts, penalty fees, and face value vs. market value differences. The Cost of Debt is widely used in credit analysis and to calculate WACC in a DCF model.<\/p><\/blockquote>\n<p>To a company, the Cost of Debt represents the all-in future annual \u201cexpense percentage\u201d of additional Debt.<\/p>\n<p>To an investor, the Cost of Debt is the <span><a href=\"https:\/\/breakingintowallstreet.com\/kb\/debt-equity\/bond-yield\/\" target=\"_blank\" rel=\"noopener\">effective annualized yield<\/a><\/span> they could expect to earn over the long term by investing in a company\u2019s Debt.<\/p>\n<p>Consider a company with $1,000 of bonds and an annual interest expense of $50.<\/p>\n<p>In this simple example, the Pre-Tax Cost of Debt is $50 \/ $1,000 = 5%.<\/p>\n<p>Since the interest on Debt is tax-deductible, you multiply by (1 \u2013 Tax Rate) to use it in the <a href=\"https:\/\/mergersandinquisitions.com\/wacc-formula\/\" target=\"_blank\" rel=\"noopener\">WACC formula<\/a>, so at a 25% tax rate, the After-Tax Cost is 5% * (1 \u2013 25%) = 3.75%.<\/p>\n<p>Of course, this is a na\u00efve approach because we don\u2019t know <strong>the market value<\/strong> of these bonds.<\/p>\n<p>For example, if overall interest rates have <strong>risen<\/strong> since this issuance, the market value of these bonds is probably less than $1,000 now, and the company would have to pay more than 5% to issue new Debt.<\/p>\n<p>As a simple example, let\u2019s say the bonds\u2019 market value is $900, and they have a 10-year maturity.<\/p>\n<p>You could calculate the <strong>yield to maturity<\/strong> on these bonds with the following Excel formula to get a more accurate estimate for the Cost of Debt:<\/p>\n<p>=YIELD(Today\u2019s Date, Maturity Date, Coupon Rate, 900 \/ 1000 * 100, 100, 2)<\/p>\n<p>Here are the results:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31376\" title=\"Cost of Debt Based on the YTM\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101809\/01-Cost-of-Debt-YTM.jpg\" alt=\"Cost of Debt Based on the YTM\" width=\"500\" height=\"447\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101809\/01-Cost-of-Debt-YTM.jpg 804w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101809\/01-Cost-of-Debt-YTM-300x268.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101809\/01-Cost-of-Debt-YTM-768x686.jpg 768w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<p>The <strong>yield to maturity<\/strong> is 6.4%, which means that if the company issued Debt today, it would have to offer a higher coupon rate because interest rates have increased.<\/p>\n<p>Assessing the Cost of Debt helps companies determine how additional borrowing will affect their profitability and cash flows and lets them make <a href=\"https:\/\/breakingintowallstreet.com\/kb\/debt-equity\/debt-vs-equity-analysis\/\" target=\"_blank\" rel=\"noopener\">Debt vs. Equity funding decisions<\/a>.<\/p>\n<p>It\u2019s also widely used in <a href=\"https:\/\/breakingintowallstreet.com\/kb\/leveraged-buyouts-and-lbo-models\/debt-schedule\/\" target=\"_blank\" rel=\"noopener\">Debt Schedules<\/a> in 3-statement models and LBO models to estimate the interest rates on future issuances.<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h3><strong>Files &amp; Resources:<\/strong><\/h3>\n<ul>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/107-32-Cost-of-Debt.xlsx\" target=\"_blank\" rel=\"noopener\">Cost of Debt \u2013 Excel Examples (XL)<\/a><\/li>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/107-32-Cost-of-Debt-Slides.pdf\" target=\"_blank\" rel=\"noopener\">Cost of Debt \u2013 Presentation Slides (PDF)<\/a><\/li>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/107-32-WES-10-K-Excerpts.pdf\" target=\"_blank\" rel=\"noopener\">Western Midstream Partners \u2013 10-K Excerpts (PDF)<\/a><\/li>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/107-32-STLD-10-K-Excerpts.pdf\" target=\"_blank\" rel=\"noopener\">Steel Dynamics \u2013 10-K Excerpts (PDF)<\/a><\/li>\n<\/ul>\n<h3><strong>Video Table of Contents:<\/strong><\/h3>\n<ul>\n<li><strong>0:00:<\/strong> Introduction<\/li>\n<li><strong>5:37:<\/strong> Part 1: Cost of Debt Interpretations<\/li>\n<li><strong>7:45:<\/strong> Part 2: Multiple Debt Issuances in Real Life<\/li>\n<li><strong>9:53:<\/strong> Part 3: No Fair Values of Debt Disclosed<\/li>\n<li><strong>12:24:<\/strong> Part 4: The Company Has No Debt<\/li>\n<li><strong>13:19:<\/strong> Recap and Summary<\/li>\n<\/ul>\n<h2><span class=\"ez-toc-section\" id=\"Interpreting_the_Cost_of_Debt_Clarifications\"><\/span><strong>Interpreting the Cost of Debt: Clarifications<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Before moving on, it\u2019s worth making one more small point: If the Cost of Debt is 6.4%, as in the example above, that doesn\u2019t necessarily mean the company will <em>pay<\/em> $64 in cash interest expense on a new $1,000 bond issuance.<\/p>\n<p>Instead, it means that investors should earn a <a href=\"https:\/\/breakingintowallstreet.com\/kb\/debt-equity\/yield-to-maturity\/\" target=\"_blank\" rel=\"noopener\">yield to maturity<\/a> of 6.4%.<\/p>\n<p>The company could let them achieve this by offering a <em>lower<\/em> coupon rate but a higher <a href=\"https:\/\/breakingintowallstreet.com\/kb\/debt-equity\/original-issue-discount-debt\/\" target=\"_blank\" rel=\"noopener\">original issue discount (OID)<\/a> or a <em>lower<\/em> coupon rate and <em>higher call premiums<\/em> or repayment penalty fees.<\/p>\n<p>For example, instead of issuing a new $1,000 bond at a 6.4% coupon rate and 10-year maturity, the company could offer one of the following:<\/p>\n<ul>\n<li><strong>Option #1:<\/strong> Issue a 6% bond at a 3% original issue discount, i.e., let investors buy it for $970 rather than $1,000. This gives them approximately 0.4% extra yield per year, boosting the YTM to ~6.4%.<\/li>\n<li><strong>Option #2: <\/strong>Issue a 5% bond with a 5% repayment penalty fee and a ~7.7% original issue discount. With this method, the company limits itself to ongoing cash payments of 5% * $1,000 = $50 per year. But the investors buy the bond for only $923, still receive $50 in interest per year, and get an additional $50 when the bond is repaid.<\/li>\n<\/ul>\n<p>You can see these examples below:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31377\" title=\"Cost of Debt Meaning and Interpretation\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101836\/02-Cost-of-Debt-Meaning.jpg\" alt=\"Cost of Debt Meaning and Interpretation\" width=\"500\" height=\"518\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101836\/02-Cost-of-Debt-Meaning.jpg 816w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101836\/02-Cost-of-Debt-Meaning-289x300.jpg 289w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101836\/02-Cost-of-Debt-Meaning-768x796.jpg 768w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<p>In most valuations and credit models, you normally assume the Cost of Debt represents the cash cost of issuing a new bond.<\/p>\n<p>These alternatives are more important for stressed or distressed companies that want to restructure while reducing their cash costs.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Calculating_the_Cost_of_Debt_in_Real_Life_Complexities_and_Missing_Information\"><\/span><strong>Calculating the Cost of Debt in Real Life: Complexities and Missing Information<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The calculations above are simple since they are not based on \u201cmessy\u201d real companies.<\/p>\n<p>But when you analyze real companies and estimate their Costs of Debt, you will run into a few common problems:<\/p>\n<ol>\n<li><strong>Multiple Debt Issuances<\/strong> \u2013 Most real companies have more than one Debt issuance, so you\u2019ll have to calculate the YTM on each one and take a weighted average.<\/li>\n<li><strong>No Fair Values Disclosed<\/strong> \u2013 Many companies, especially smaller ones, do not disclose the fair value or fair market value of their Debt, so it\u2019s not possible to use the YIELD function in a meaningful way.<\/li>\n<li><strong>No Debt<\/strong> \u2013 Finally, some companies may not have any Debt. In this case, you\u2019ll have to rely on the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/comparable-company-analysis-cca\/\" target=\"_blank\" rel=\"noopener\">comparable public companies<\/a> and make adjustments to estimate the company\u2019s Cost of Debt.<\/li>\n<\/ol>\n<p>To illustrate these scenarios, we\u2019ll use <strong>Western Midstream Partners<\/strong> (an oil &amp; gas company in the midstream sector) and <strong>Steel Dynamics<\/strong> in a few examples.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Calculating_the_Cost_of_Debt_in_Real_Life_Multiple_Issuances\"><\/span><strong>Calculating the Cost of Debt in Real Life: Multiple Issuances<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>If the company discloses the fair value of each issuance, this issue is simple: Calculate the YTM of each one and use the weighted average to approximate the Cost of Debt.<\/p>\n<p>Here are Western Midstream Partners\u2019 disclosures:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31378\" title=\"Fair Value of Debt for Western Midstream Partners\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101909\/03-WES-Fair-Value-Debt-1024x843.jpg\" alt=\"Fair Value of Debt for Western Midstream Partners\" width=\"500\" height=\"412\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101909\/03-WES-Fair-Value-Debt-1024x843.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101909\/03-WES-Fair-Value-Debt-300x247.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101909\/03-WES-Fair-Value-Debt-768x632.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101909\/03-WES-Fair-Value-Debt.jpg 1484w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<p>And here are our calculations based on the weighted average YTM:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31379\" title=\"Cost of Debt Based on YTM for Western Midstream Partners\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101928\/04-WES-Cost-of-Debt.jpg\" alt=\"Cost of Debt Based on YTM for Western Midstream Partners\" width=\"500\" height=\"403\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101928\/04-WES-Cost-of-Debt.jpg 822w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101928\/04-WES-Cost-of-Debt-300x242.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101928\/04-WES-Cost-of-Debt-768x619.jpg 768w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<p>Since WES is a Master Limited Partnership (MLP), its corporate tax rate is 0% or close to 0%, which means that multiplying by (1 \u2013 Tax Rate) barely changes the Cost of Debt:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31380\" title=\"Impact of Taxes on the Cost of Debt\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101954\/05-WES-Taxes.jpg\" alt=\"Impact of Taxes on the Cost of Debt\" width=\"500\" height=\"196\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101954\/05-WES-Taxes.jpg 974w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101954\/05-WES-Taxes-300x118.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07101954\/05-WES-Taxes-768x301.jpg 768w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<p>As an example for a company with corporate-level taxes, here are the numbers for Steel Dynamics:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31381\" title=\"Steel Dynamics - Cost of Debt Calculation\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102033\/06-STLD-Cost-of-Debt.jpg\" alt=\"Steel Dynamics - Cost of Debt Calculation\" width=\"500\" height=\"162\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102033\/06-STLD-Cost-of-Debt.jpg 1170w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102033\/06-STLD-Cost-of-Debt-300x97.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102033\/06-STLD-Cost-of-Debt-1024x331.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102033\/06-STLD-Cost-of-Debt-768x248.jpg 768w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Calculating_the_Cost_of_Debt_in_Real_Life_No_Fair_Values_Disclosed\"><\/span><strong>Calculating the Cost of Debt in Real Life: No Fair Values Disclosed<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>If the company you\u2019re valuing does not disclose the \u201cfair value\u201d or \u201cfair market value\u201d of its Debt, you have several options.<\/p>\n<p><strong>First<\/strong>, you could look at the comparable public companies, see if any of them disclose the fair value of their Debt, and base the Cost of Debt on their numbers (e.g., the median YTM for the set).<\/p>\n<p>This method works, but is time-consuming and may not produce useful results if only a few companies disclose the fair values.<\/p>\n<p><strong>Second<\/strong>, you could take the average interest rate on the company\u2019s Debt and use that for its Cost of Debt.<\/p>\n<p>For example, with Western Midstream, we could have done the following to estimate its Cost of Debt:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31382\" title=\"Simple Interest Rate Method for the Cost of Debt\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102207\/07-WES-Simple-Interest-Rate-Method.jpg\" alt=\"Simple Interest Rate Method for the Cost of Debt\" width=\"500\" height=\"180\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102207\/07-WES-Simple-Interest-Rate-Method.jpg 844w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102207\/07-WES-Simple-Interest-Rate-Method-300x108.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102207\/07-WES-Simple-Interest-Rate-Method-768x277.jpg 768w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<p>This produces a 4.8% Pre-Tax Cost of Debt, which is fairly close, but it\u2019s still a big enough difference to affect the valuation.<\/p>\n<p><strong>Finally,<\/strong> you could take the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/risk-free-rate\/\" target=\"_blank\" rel=\"noopener\">Risk-Free Rate<\/a> and add the company\u2019s estimated Credit Default Spread based on its credit rating.<\/p>\n<p><span><a href=\"https:\/\/pages.stern.nyu.edu\/~adamodar\/New_Home_Page\/datafile\/ratings.html\" target=\"_blank\" rel=\"noopener\">Damodaran has an annually updated list right here<\/a><\/span>, which we used for an alternative calculation:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-31383\" title=\"Default Spread Method for the Cost of Debt\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102230\/08-WES-Cost-of-Debt-Default-Spread.jpg\" alt=\"Default Spread Method for the Cost of Debt\" width=\"500\" height=\"153\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102230\/08-WES-Cost-of-Debt-Default-Spread.jpg 832w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102230\/08-WES-Cost-of-Debt-Default-Spread-300x92.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102230\/08-WES-Cost-of-Debt-Default-Spread-768x234.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/05\/07102230\/08-WES-Cost-of-Debt-Default-Spread-325x100.jpg 325w\" sizes=\"(max-width: 500px) 100vw, 500px\" \/><\/p>\n<p>Although WES has a high interest coverage ratio (&gt; 3.0x and &gt; 4.0x in some periods), both S&amp;P and Fitch have given it a \u201cBBB-\u201c credit rating.<\/p>\n<p>Therefore, we took the 1.2% spread from Damodaran\u2019s current chart and added it to the U.S. Risk-Free Rate of 4.2% at the time of this valuation to get a Pre-Tax Cost of Debt of 5.4%.<\/p>\n<p>This is lower than the 5.7% YTM but is more accurate than the \u201csimple interest expense\u201d method.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Calculating_the_Cost_of_Debt_in_Real_Life_No_Debt\"><\/span><strong>Calculating the Cost of Debt in Real Life: No Debt<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>One final complexity is that you may have to calculate the Cost of Debt for a company that does not have any Debt currently.<\/p>\n<p>The simple interest rate, yield to maturity, and risk-free rate + credit default spread methods do <strong>not<\/strong> work in this case.<\/p>\n<p>All you can do here is calculate the Cost of Debt for its comparable public companies and perhaps add a \u201csize\/risk premium\u201d if it is much smaller.<\/p>\n<p>For example, you might do this if you\u2019re valuing a tech startup and comparing it to public companies with $100+ million in revenue.<\/p>\n<p>A new tech startup with low revenue is <em>much<\/em> riskier than companies with hundreds of millions in revenue, so its Cost of Debt should be higher.<\/p>\n<p>Opinions vary on how much of a size\/risk premium to add, but something in the 20 \u2013 40% range might be appropriate.<\/p>\n<p>So, if the public companies\u2019 median YTM is 8%, perhaps your company\u2019s Cost of Debt is 10% or 11%, representing premiums in that 20 \u2013 40% range.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The Cost of Debt in corporate finance represents the effective rate a company would pay if it issued additional Debt today; most of this cost is the Interest Expense on the Debt, but some may also correspond to discounts, penalty fees, and face value vs. market value differences. The Cost of Debt is widely used in credit analysis and to calculate WACC in a DCF model.<\/p>\n","protected":false},"featured_media":0,"template":"","class_list":["post-31375","biws_kb","type-biws_kb","status-publish","hentry","kb_category-valuation"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/31375","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=31375"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}