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

Kaveri Ltd has 12% debentures of ₹1,000 face value, issued at par, redeemable at par after 5 years, with a tax rate of 25%. Using the approximation formula, what is the post-tax cost of debt? Ignore floatation costs.

Since the debentures are issued and redeemed at par with no floatation cost, the pre-tax cost equals the 12% coupon. Applying the tax shield, post-tax cost is 12% × (1 - 0.25), which equals 9%.

  1. A9.00%Correct
  2. B12.00%
  3. C6.00%
  4. D7.50%

Explanation

Issued and redeemed at par with no floatation cost, so pre-tax Kd = 12%. Post-tax = 12% × (1 - 0.25) = 9%. 12% ignores tax shield; 7.50% wrongly applies tax as 12 × 0.625 or similar error; 6% halves the rate.

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