CS Executive · Corporate Accounting and Financial Management · Cost of Capital
Arjun Ltd. issues 12% debentures of Rs 1,000 face value at par, redeemable at par after 5 years. Flotation cost is Rs 50 per debenture on issue. Using the approximate yield formula with the average of net proceeds and redemption value as the denominator, what is the pre-tax cost of debt (rounded to one decimal)?
The pre-tax cost works out to about 13.3% using the approximate yield method, which does not match the listed answer; this question should be discarded.
- A12.0%
- B13.8%Correct
- C12.6%
- D14.8%
Explanation
Net proceeds = 1,000 - 50 = Rs 950. Annual interest = Rs 120. Annual amortisation of cost = (1,000 - 950)/5 = Rs 10. Numerator = 130. Average = (1,000 + 950)/2 = 975. Kd = 130/975 = 13.33%. Rounded this is 13.3%, so the correct option must be checked: 130/975 = 0.1333, so 13.8% is not correct.
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