Cost of variable-rate debt
Variable-rate interest changes when the contractual reference rate resets. A simple appraisal estimate may use the current or forecast reference rate plus the lending margin, adjusted for usable interest tax relief. Fees, floors, caps, reset intervals and changes in credit margin can alter the effective cost. The formula rate × (1 − T) assumes the interest deduction is available and timed consistently; it is not a universal way to value every debt instrument. A floating rate reduces some price sensitivity but exposes the borrower to uncertainty over future cash interest.
Worked example
A loan charges a reference rate of 4.2% plus 1.3%, giving 5.5% before tax. With an illustrative 20% immediately usable tax deduction, the simple after-tax cost is 4.4%. If the reference rate rises by 1 percentage point, before-tax cost becomes 6.5% unless contractual protection applies.
Common mistake
Treating the current floating rate as fixed for the loan's entire life, or applying the debt tax adjustment to equity returns.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |