CA Inter P6 · Chapter 4 · Question 2 of 10
A company issues 10% debentures of ₹ 1,000 each. Net proceeds per debenture are ₹ 940, and the debentures are redeemable at a 5% premium after 8 years. The tax rate is 25%. Using the approximation formula, the after-tax cost of debt is closest to:
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: C) 8.92%
Explanation
Redemption value RV = ₹ 1,050 and NP = ₹ 940. Kd = [I(1 - t) + (RV - NP)/n] / [(RV + NP)/2] = [100 x 0.75 + (1,050 - 940)/8] / [(1,050 + 940)/2] = (75 + 13.75) / 995 = 8.92%. Ignoring tax gives 11.43%. Dividing by NP alone gives 9.44%, and ignoring the redemption premium gives 8.51%.
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