CS Professional · Strategic Management and Corporate Finance · Raising of Funds from Debt and Procedural Aspects
Meridian Components Ltd borrows Rs 50,00,000 through a term loan at 12% per annum. The tax rate is 25% and interest is fully deductible. What is the post-tax cost of this debt?
The post-tax cost of debt is 9%. Interest is tax deductible, so the effective cost is the 12% rate multiplied by one minus the 25% tax rate. Ignoring the tax shield would wrongly give 12%.
- A12%
- B9%Correct
- C3%
- D16%
Explanation
Post-tax cost of debt = pre-tax rate x (1 - tax rate) = 12% x (1 - 0.25) = 9%. Option 12% ignores the tax shield. Option 16% divides by (1 - t) instead of multiplying, which is the wrong direction. Option 3% subtracts the tax rate in the wrong manner.
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