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

Mehta Textiles has issued 10% irredeemable debentures of Rs 100 each at par. The tax rate is 25%. The cost of debt after tax is:

The after-tax cost of debt is 7.5%. The coupon of 10% on par value is the pre-tax cost for irredeemable debentures issued at par, and interest is tax deductible, so it is multiplied by one minus the tax rate of 25 percent, giving 7.5 percent.

  1. A10.00%
  2. B12.50%
  3. C7.50%Correct
  4. D2.50%

Explanation

For irredeemable debentures issued at par with no costs, pre-tax cost = 10/100 = 10%. After-tax cost = 10% x (1 - 0.25) = 7.5%. Option 12.50% wrongly divides by (1 - t) and 2.50% deducts only the tax amount.

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