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CS Executive · Corporate Accounting and Financial Management · Cost of Capital

Sundaram Ltd issues perpetual debentures of face value ₹1,000 each at par with a coupon of 10% per annum. The tax rate is 25%. Ignoring issue costs, what is the after-tax cost of debt?

The after-tax cost of debt is 7.5%. Interest on debentures is tax deductible, so the effective cost equals the 10% coupon multiplied by one minus the 25% tax rate, giving 7.5%. Using 10% would ignore the tax shield.

  1. A10.0%
  2. B7.5%Correct
  3. C12.5%
  4. D2.5%

Explanation

Kd after tax = coupon × (1 − tax rate) = 10% × (1 − 0.25) = 7.5%. The 10% option ignores the tax shield on interest. The 12.5% option wrongly divides by (1 − t) instead of multiplying.

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