Understanding the After-Tax Cost of Debt in the WACC Formula

Summary

The document asks whether the weighted average cost of capital (WACC) should apply the tax adjustment twice when the cost of debt is described as an interest rate multiplied by one minus the tax rate. It highlights a notation problem: the standard WACC expression already multiplies the debt weight and debt cost by the after-tax factor, while some explanations also call an after-tax quantity the cost of debt.

The key distinction is between the pretax cost of debt, typically represented by the borrowing rate, and its after-tax contribution to WACC. If the debt-cost input is already tax-adjusted, applying the WACC tax factor again would double-count the adjustment. The document itself contains only the question and no answer, derivation, or worked example, so it does not explain how to estimate the borrowing rate or address complications such as tax-deductibility limits. The notation distinction is still useful when reading valuation models and checking whether a formula applies taxes once or twice.

Key ideas

• In the standard WACC expression, the debt component is adjusted for taxes.
• The debt cost input may refer to a pretax borrowing rate or an already tax-adjusted rate.
• Applying the tax adjustment twice would double-count it.
• The document poses the issue but supplies no worked solution or treatment of tax complications.

Tags

# Rewriting WACC Formula


# Rewriting WACC Formula












$WACC = \frac{E}{V} * R_e + \frac{D}{V} *R_D(1-T_c) $

where $R_D$ should be the cost of the debt. $T_c$ is the tax rate. When googling the formula for cost of debt I find $Cost of debt = R_D = Interest*(1-tax rate)$

But this looks identical to the $R_D(1-T_c$) part, if only $R_d$ was interest rate in the WACC Formula. Does this mean we can rewrite WACC to

$WACC = \frac{E}{V}*R_e +\frac{D}{V}*r_i*(1-T_c)^2$ where $r_i$ is the interest rate, or is there something I'm not understanding correctly here?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.