If this corporation raises $100,000 as equity, there is no interest payment and the company pays $3,000 corporate taxes. However, in case of borrowing $100,000 at an interest rate of 5%, ABC pays $5,000 of interest which is deducted from the earnings which results in $1,500 of tax payments. By paying $5,000 interest, ABC waives from $1,500 tax payment. Therefore, the real cost of borrowing is $5,000-$1,500 which is $3,500. This can also be observed by the difference in the net income between the two financing options: