Saturday Brain Storming Thought (138) 06/11/2021
COMPILED BY ER. AVINASH KULKARNI
COST OF DEBT
The cost of debt is the effective interest rate that a company pays on its debts, such as bonds and loans
Key Takeaways
1) the cost of debt is the effective rate that a company pays on its debts, such as bonds and loans
2) the key difference between the pretax cost of debt and the after-tax cost of debt is the fact that interest expense is tax-deductible
3) debt is one part of a company’s capital structure, with the other being equity
4) calculating the cost of debt involves finding the average interest paid on all of a company’s debt
Cost of debt calculation
1) add up all loans, balances on credit cards and other financing tools of the company have
2) calculate the interest rate expense for each for the year and add those up
3) divide your total interest by your total debt to get your cost of debt
Cost of debts in economics
It is the effective rate of interest a firm pays on its debts
Ways for reducing the cost of debt
1) Find ways to get a lower interest rate
a) take actionable steps to improve your credit score
b) offer to put down business or personal assets as collateral
c) get additional guarantors to sign your business loan
d) negotiate a decrease in interest rate with the lender after a certain number of online payments
2) Refinance your loan
a) refinancing won’t lower your cost of debt right away but is a long term strategy
b) make merchants more credible in the eyes of lenders
c) business owners can restructure their installments or lower their overall interest rate
3) Maximise your business’s growth potential
a) increase profit margin
b) use loan cost to generate business income
4) Shorten your repayment period
If you have the cash flow, you can lower your cost of debt by taking out a loan with a shorter repayment term
Key learning points about the cost of debt
1) cost of debt is the return on debt capital and is often denoted as Kd
2) the cost of debt should be tax adjusted at the marginal tax rate because interest is tax deductible
3) debt is the amount of money borrowed by one party to the other under the condition that it is repaid at later date
4) when calculating the cost of debt, only the most recent figures should be used and balance sheet numbers should be used as a last resort
Cost of debt formula
Kd = [I (1+t) + (f+d+Pr-Pi/m] / (RV + SV)/2
I = interest payment
RV = Redeemable value of debt
SV = Net proceeds (face value – issue expenses)
Nm = term of debt
F = flotation cost
d = discount on issue of debentures
pi = premium on issue of debt
T = tax rate
Short term debts
1) accounts payable
2) wages payable
3) short term notes
4) deferred revenues
5) current portion of long term debt
Long term debt
Kind of any Lian a company has received to operate a business that surpasses a 12 months period
1) long term loans
2) capital leases
3) pension liabilities
4) bonds payable
5) deferred compensation
6) deferred income taxes
Jobs for those who calculate total debt
1) accountant
2) bookkeeper
3) personal financial advisor
4) finance director
5) corporate controller
6) budget analyst
7) accounting clerk
8) credit analyst
9) accounting manager
10) financial business analyst
Ideas for reducing debts
1) know your numbers – cost, penalty, interest rate
2) be smart about your ordering – identify unprofitable sales and try to eliminate them
3) increase your profit margins
4) watch your inventory
5) check your interest rates
6) talk about the terms of payments and receivable
7) sell and lease back
8) take opinions from employees
9) be tougher on your customers
10) reduce unrequited staff
11) speak to a credit counselor
12) hire a debt management company
13) bring on an investor
Compiled by:-
Er. Avinash Kulkarni
Chartered Engineer
Govt Regd Valuer
IBBI Regd Valuer
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