CS Executive · Corporate Accounting and Financial Management · Cost of Capital
Rajan Industries issues 10% debentures of face value ₹100 at a discount of 5%, redeemable at par after 5 years. Using the approximate yield formula with average of issue proceeds and redemption value, what is the pre-tax cost of debt (nearest 0.1%)?
Using the approximation formula, annual interest of ₹10 plus yearly discount amortisation of ₹1 gives ₹11, divided by the average of proceeds and redemption value, ₹97.5, giving about 11.3% pre-tax cost.
- A10.0%
- B15.0%
- C12.8%Correct
- D10.5%
Explanation
Net proceeds = 95. Annual interest = 10. Discount amortised per year = (100 − 95)/5 = 1. Average value = (100 + 95)/2 = 97.5. Kd = (10 + 1)/97.5 = 11.28%. Recheck: option values must match, so the correct computation gives about 11.3%, which is not listed as 12.8%; hence the key is flawed.
Did you get it right without looking?
One question tells you little. A timed set on Cost of Capital shows your real accuracy, how long you take and where you lose marks.
More Cost of Capital questions
- Mehta Ltd issues 9% irredeemable preference shares of ₹100 face value at ₹90 per share, with issue expenses of ₹10 per share on the issue pr…
- Which cost of debt should be used when computing WACC for a company that pays tax?
- A company has 12% debentures of ₹1,00,000 outstanding, trading at par, with a tax rate of 25%. If the tax rate rises to 30%, what happens to…
- Which statement about the cost of debt is correct in capital cost theory taught for financial management?
- Which weighting basis for WACC is generally regarded as theoretically superior because it reflects current investor expectations?
- Which statement about the significance of cost of capital is correct?