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CA Intermediate · Financial Management and Strategic Management · Cost of Capital

Kaveri Foods Ltd has 12% irredeemable debentures of ₹1,000 each issued at par, with no issue cost. The tax rate is 25%. What is the after-tax cost of debt?

The after-tax cost of debt is 9%. Interest of ₹120 on a ₹1,000 debenture is tax-deductible, so the effective interest is 120 × (1 - 0.25) = ₹90. Dividing by the ₹1,000 proceeds gives 9%, lower than the 12% coupon because of the tax shield.

  1. A12%
  2. B3%
  3. C9%Correct
  4. D16%

Explanation

Kd after tax = Interest × (1 - t) / Net proceeds = 120 × 0.75 / 1,000 = 9%. 12% ignores the tax shield. 3% wrongly applies only the tax rate to the interest rate. 16% divides by (1 - t), which grosses up instead of reducing.

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