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

Kaveri Ltd issues 10% irredeemable debentures of ₹1,000 face value, 1,000 in number, at par. Floatation cost is 2% of the issue. Tax rate is 25%. Using the standard approximation for irredeemable debentures, the post-tax cost of debt is nearest to:

Post-tax cost of debt is about 7.65 percent. Net proceeds per debenture are ₹980 after 2 percent flotation cost, interest is ₹100, giving a pre-tax cost of 10.20 percent. Multiplying by one minus the 25 percent tax rate gives 7.65 percent.

  1. A7.65%Correct
  2. B10.20%
  3. C7.50%
  4. D9.80%

Explanation

Net proceeds per debenture = 1,000 x 0.98 = 980. Interest = 100. Pre-tax cost = 100/980 = 10.204%. Post-tax = 10.204 x (1 - 0.25) = 7.65%. Option 10.20% ignores tax; 7.50% ignores flotation cost.

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