To find the cost of debt, divide a company’s total interest expense by its total debt to get the pre-tax rate, then multiply that rate by (1 − marginal tax rate) to get the after-tax cost of debt. The after-tax figure is the one that matters for most financial decisions, because interest is generally deductible and that tax shield reduces the real cash cost of borrowing. A company paying $60,000 in annual interest on $1,200,000 of debt has a pre-tax cost of 5 percent; at a combined marginal tax rate of about 25.7 percent, the after-tax cost drops to roughly 3.7 percent.
The mechanics are simple once you have the three inputs. Getting the inputs right is where most of the work sits.
The Three Numbers You Need
Total interest expense, total debt, and the marginal tax rate. Any one of them wrong throws off the answer.
Total Interest Expense
Interest expense appears on the income statement, usually as its own line under non-operating expenses. It captures what the company paid during the period on bank loans, bonds, credit facilities, and similar obligations. Pull the specific interest line rather than a broader operating-expense category, since those categories fold in costs that have nothing to do with borrowing.
Total Debt
Total debt comes from the balance sheet: short-term borrowings such as notes payable due within a year, plus long-term debt such as term loans and bonds. Leave out accounts payable, accrued wages, and other non-interest-bearing liabilities. They’re obligations, but they don’t carry an interest rate, and including them dilutes the result.
Finance leases are worth a second look. Under current accounting standards, a finance lease creates a balance-sheet liability that accrues interest like a loan. If the company carries material finance leases, the interest component already sits inside interest expense, and the lease liability belongs in total debt. Skip it and you understate the true borrowing cost.
Marginal Tax Rate
The marginal tax rate is the rate applied to the company’s last dollar of income. For C corporations, the federal rate is a flat 21 percent under the Tax Cuts and Jobs Act, still in effect for 2026. Most businesses also owe state corporate income tax. Forty-four states levy one, with top marginal rates running from roughly 2 percent to 11.5 percent. Using 21 percent alone understates the tax shield and therefore overstates the after-tax cost of debt.
Because state taxes are deductible on the federal return, the combined rate isn’t a simple sum. The standard shortcut is:
Combined Rate = Federal Rate + (1 − Federal Rate) × State Rate
For a company in a state with a 6 percent corporate tax, that works out to about 25.7 percent, not 27 percent. The notes to the financial statements or Form 1120 often already show an effective rate that reflects this calculation.
Calculating the Pre-Tax Cost of Debt
Divide total interest expense by total debt. If a company pays $60,000 in annual interest on $1,200,000 of debt, the pre-tax cost is 5 percent. That’s the average rate across every obligation on the books, before any tax adjustment.
When the number comes from the income statement and balance sheet directly, the division already produces a blended figure. If instead you’re building it up from individual loan terms, use a weighted average: multiply each loan’s balance by its rate, sum the products, and divide by total debt. Weighting matters because a $900,000 loan at 4 percent should dominate a $100,000 loan at 10 percent, which is how the actual interest burden works.
When to Use Yield to Maturity Instead
For companies with publicly traded bonds, the coupon rate on the bond is not the cost of debt. Coupons are fixed at issuance and ignore what the market is charging today. A bond trading below face value has an effective cost higher than its coupon; one trading above has a lower cost. Yield to maturity factors in the current market price, remaining coupon payments, and time to maturity, so it gives a truer picture of what the debt is actually costing. Use YTM whenever bond prices are available.
Applying the After-Tax Formula
Interest is generally deductible as a business expense, which is why the after-tax cost of debt is always lower than the pre-tax cost. The formula:
After-Tax Cost of Debt = Pre-Tax Cost of Debt × (1 − Marginal Tax Rate)
Take a 6 percent pre-tax cost of debt and a combined marginal tax rate of 25.7 percent. Multiply 6 percent by (1 − 0.257), or 0.743, and the after-tax cost lands at about 4.46 percent. On $1 million of debt, that 1.54-percentage-point gap is worth roughly $15,400 a year in tax savings. Running the same math with only the 21 percent federal rate gives 4.74 percent, which looks close but overstates the true cost because it ignores the state tax deduction.
This after-tax number is the one that belongs in financial models and in the weighted average cost of capital. It reflects the actual cash outflow the company experiences once the return is filed.
Where the Formula Breaks: Section 163(j)
The after-tax formula assumes every dollar of interest is deductible. That’s not always true. Section 163(j) of the tax code caps business interest deductions at the sum of business interest income, 30 percent of adjusted taxable income, and any floor plan financing interest. Interest above the cap isn’t lost; it carries forward to future years and gets deducted on a first-in-first-out basis when there’s room under the cap.
For 2026, adjusted taxable income is calculated by adding back depreciation, amortization, and depletion. That’s more generous than the 2022–2024 rules, and it means capital-intensive businesses can deduct more interest than they could in recent years.
Small businesses are exempt. If a company’s average annual gross receipts over the prior three years don’t exceed $32 million (the inflation-adjusted threshold for 2026), Section 163(j) doesn’t apply. Above that threshold, a disallowed portion of interest shrinks the effective tax shield, and the true after-tax cost of debt runs higher than the plain formula suggests. Rerun the after-tax calculation using only the currently deductible portion of interest to see the real number.
Sanity-Checking Against Industry Benchmarks
A cost-of-debt figure means more with a reference point. According to data compiled by NYU Stern as of January 2026, the pre-tax cost of debt for the overall U.S. market, excluding financial firms, runs around 5.29 percent. Sector figures vary:
- Software and computer services: about 5.3 percent
- General retail: about 5.1 percent
- Machinery: about 5.3 percent
- Steel: about 9.3 percent, reflecting higher credit risk in a cyclical industry
A cost of debt well above the industry average usually points to a weak credit profile, unfavorable loan terms worth renegotiating, or a debt mix leaning heavily on expensive short-term borrowing. A figure well below average may reflect strong creditworthiness, or it may reflect old fixed-rate debt that hasn’t yet repriced and will jump at renewal. The benchmark won’t answer those questions on its own, but it tells you which questions to ask next.