The marginal tax rate is the percentage of tax applied to an additional dollar of income earned. In most tax systems, as income increases, it is taxed at progressively higher rates within different tax brackets.
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The marginal tax rate represents the highest rate that applies to a company’s last unit of taxable income. For businesses, the marginal tax rate is crucial in financial modeling and valuation, as it directly affects cash flow projections and after-tax profitability.

The Weighted Average Cost of Capital (WACC) represents a company’s overall cost of capital, considering both equity and debt financing. Since interest payments on debt are tax-deductible, the cost of debt is adjusted using the marginal tax rate in the WACC formula:
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Where:

The marginal tax rate is used in WACC instead of the average tax rate because it better reflects the actual tax savings a company receives on additional debt financing.
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Since WACC is used to evaluate future investment decisions, using the marginal tax rate ensures that the calculation aligns with the tax rate that will apply to new earnings. This results in a more accurate estimation of a company's effective financing costs.
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By understanding and applying the marginal tax rate correctly, businesses can make more informed decisions about their capital structure and investment strategies.