Wacc formula
Since I started my CFA journey from a non-finance background (being a maths addict in secondary/6th form), I always enjoyed trying to understand the "logic" behind why every single minute component of each formula I came across. I never quite understood why the cost of debt component would have taxation rate subtracted, could someone throw more light on why (if at all) a bond issuer would end up spending less on debt servicing as the tax rate goes up. PS: please remind me, is "cost of debt" the coupon or discount rate used in pricing?
Taxation rate isn't subtracted from cost of debt, the inverse of the tax rate is multiplied to cost of debt. Rd x (1-Tc) where Tc is tax rate and Rd is cost of debt. If tax rate increases, lower cost of debt. This is due purely to the fact that interest payments are tax deductible
Could you explain "tax deductibility"?
I live in a place where taxation isn't significant
Essentially, any expense that's above the tax line on the income statement is tax deductible, meaning that it reduces the amount of taxes you pay. Since interest comes before taxes, and lowers your pre-tax income, it is considered tax deductible. The higher interest expense the less taxes you pay. Eg. if I have $100 EBIT and in one scenario I have $10 interest expense and another scenario with $20 interest expense, my pre tax income is going to be $90 and $80 respectively. With a 50% tax rate, your after tax income will be $45 and 40$ respectively. You see how with the higher interest expense scenario you paid less in taxes (even though your net income is lower)?
Cost of debt is YTM
Quis dignissimos modi dolor dolorem iste et. Et assumenda tempora natus ex. Amet voluptate et incidunt totam aspernatur consectetur. Neque porro quod cum et reiciendis porro id laudantium.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Velit sunt nihil porro tempore quas. Voluptatum quis deserunt occaecati eius eaque. Ratione rem aliquid corrupti numquam voluptas dignissimos. Quidem molestiae velit sit accusamus ut. Et libero doloribus nisi deleniti harum nulla.
Error tempora maiores voluptatem voluptatem. Nostrum ex et qui enim.
Quis quaerat omnis nobis fuga enim. Alias beatae deleniti est eaque et aliquid. Est quo nesciunt cupiditate est.
Quis dolor natus iste vel error. Labore nemo repellat explicabo voluptates minima eos possimus iste.