CA Intermediate · Financial Management and Strategic Management · Cost of Capital
Kaveri Industries issued 12% irredeemable debentures of ₹1,000 each at par. Flotation cost is 2% of face value, and the tax rate is 25%. What is the post-tax cost of debt (approximately)?
The post-tax cost of debt is about 9.18%. Net proceeds after 2% flotation cost are ₹980, interest is ₹120, so pre-tax cost is 12.245%. Multiplying by one minus the 25% tax rate gives approximately 9.18%.
- A9.18%Correct
- B9.00%
- C12.24%
- D12.00%
Explanation
Net proceeds = 1,000 - 20 = ₹980. Interest = ₹120. Pre-tax cost = 120/980 = 12.245%. Post-tax = 12.245% x (1 - 0.25) = 9.18%. Option 9.00% ignores flotation cost, while 12.24% ignores the tax shield.
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