Why cost of debt matters to a first-time founder
Cost of debt shows what borrowing really costs and feeds into financing and investment decisions. Looking beyond the advertised interest rate matters because fees, discounts, and changing rates can raise the effective cost. It also helps founders compare a loan with other funding without pretending that equity has no cost.
Examples of cost of debt
A company borrows ₹10 million at 8% annual interest and pays ₹200,000 in arrangement fees. A simple first-year pre-tax cost is ₹1 million divided by ₹10 million, or 10%. A full effective-rate calculation spreads fees over the loan’s life and accounts for repayment timing. After-tax cost depends on whether local rules allow interest deductions.
Common misunderstanding
Cost of debt is not always the coupon or stated loan rate. The effective cost can include fees and the price at which debt was issued. An after-tax figure may be lower than the pre-tax figure, but only where the borrower can use the deduction under the applicable tax law.
When to use it
Use it when comparing loans, leases, bonds, or a debt-and-equity funding mix. Match calculations by term, currency, security, and whether rates are fixed or variable. For a straightforward small-business loan, an annual percentage rate may be a useful starting point, but confirm what fees and assumptions it includes.