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CA Intermediate · Financial Management and Strategic Management · Types of Financing

Aarav Ltd issues 10% debentures of face value Rs 1,00,000 in total, redeemable at par after 5 years, at an issue price of Rs 95 per Rs 100 (i.e. total proceeds Rs 95,000). Ignoring tax and issue costs and using the approximation Kd = [I + (RV - NP)/n] / [(RV + NP)/2], what is the approximate pre-tax cost of the debentures?

The approximate pre-tax cost is 11.28%. Annual interest is Rs 10,000 plus yearly discount amortisation of Rs 1,000, giving Rs 11,000, which is divided by the average of redemption value and net proceeds, Rs 97,500. Ignoring the discount would understate the cost.

  1. A10.00%
  2. B11.28%Correct
  3. C12.82%
  4. D10.53%

Explanation

Interest = 10,000. Annual discount amortisation = (1,00,000 - 95,000)/5 = 1,000. Numerator = 11,000. Denominator = (1,00,000 + 95,000)/2 = 97,500. Kd = 11,000/97,500 = 11.28%. Using 11,000/95,000 would give 11.58%, and 10,000/95,000 gives 10.53%, which ignores the discount.

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