Question

How do you work out the kd (or the cost of debt) in WACC?

Answer 1

The cost of debt (kd) is the return that a company provides to its debt holders. It is an effective interest rate that a company pays on its debt. It is the amount paid as a compensation for risk associated with the debt in which the debt holder has invested his money. Kd is an integral part while calculating the Weighted Average Cost of Capital (WACC) of the company. It is usually post-tax cost of debt.

The formula to calculate WACC is:

WACC = (E/V * Ke) + (D/V) * Kd * (1 - tax rate)

where,

E = Market Value of equity

V = Total market value of debt and equity

Ke = Cost of equity

D = market value of debt

Kd = Cost of debt

Tax rate = Corporate tax rate