IAI Actuarial Core Principles · Business Finance · Cost of capital and evaluating investment projects
Arjun Infra Ltd has irredeemable debentures with a coupon of 10% on a nominal value of Rs 100. They trade at Rs 80 ex-interest. The corporate tax rate is 30%. What is the post-tax cost of debt?
The post-tax cost of debt is 8.75%. Annual interest of Rs 10 falls to Rs 7 after 30% tax relief, and for irredeemable debt the cost is this after-tax interest divided by the market price of Rs 80. Using nominal value would wrongly give 7%.
- A7.0%
- B8.75%Correct
- C10.0%
- D12.5%
- 9.0%
Explanation
Post-tax interest = 10 x (1 - 0.30) = Rs 7. Cost = 7/80 = 8.75%. Choosing 7.0% divides by nominal value instead of market price, and 12.5% is the pre-tax cost (10/80).
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