How to calculate after-tax interest expense

Research
1

Hi,
any ideas how to best calculate after-tax interest expense? Am I right that the P123 formula IntExpTTM is before taxes?

Thanks!
Michael

2

Well, the simple approach would be:

IntExpTTM-((TxRate%TTM/100)*IntExpTTM)

That would just get you the interest expense less a percentage equal to the tax rate.

The problem is the meaning of the actual data.

So, first off, “tax rate” is a state of mind in financial reporting. If a company has no profit then their tax rate drops to zero. Or more accurately less than zero, because they usually get some transferable net-operating-loss tax credits that turn into assets on the balance statement. That effect leads to a whole bunch of tax rates in the database that are, from a common sense perspective, kind of nonsensical. Right now the highest tax rate is MDWT at 3,136% and the lowest is FSTR at -8,860%. Those are basically meaningless outliers, so you’ll want to pare the ends, perhaps with:

TxRate%TTM<60 and TxRate%TTM>0

Second, interest expense is frequently a net negative rather than separate from interest income, so you’ll want to get rid of the negatives (that is, those companies with net income):

IntExpTTM>0

But third, and most problematic, the tax rate that we have is the overall percentage of tax paid relative to income before taxes. However, the debt service/net interest income is pretty much specifically going to have a different tax rate.

Or at least that’s how I recall it. It’s been enough years since I last did this stuff that the corporate tax rules might have changed.

As an analyst, this is the kind of thing that you ask the company about. I would question in my mind whether a back-of-the-envelope analysis is going to be helpful. But that’s what testing is for. :slight_smile:

3

Paul’s mostly right (the only thing he’s wrong about is that IntExpTTM is never less than 0; IntExp is calculated separately from interest income and consists only of the interest a company pays to service its debt). But you need to use something if you want to guess at a company’s unlevered free cash flow, for instance. FWIW, I usually use either 0.8IntExpTTM or IntExpTTM(1-TaxRate%TTMInd/100). But what’s important, as Paul rightly points out, is NOT to use TxRate%TTM.

4

Your explanations are very helpful. Yes, I want to use it for calculating the unlevered free cash flow. Thanks a lot to both of you :slight_smile: