The Cost of Debt represents the effective interest rate a company pays on its borrowed funds, adjusted for both risk and inflation. It combines a reference risk-free rate with a technology debt premium, which reflects sector-specific risks. The premium is usually lower than the equity premium because debt carries less risk in terms of repayment and guarantees.
The formula is:
Cost of Debt = (Reference risk-free rate + Tech debt premium) – Inflation
This produces the real cost of debt—the inflation-adjusted interest rate—capturing the true financial burden of borrowing in today’s money.