CMA Intermediate · Financial Management and Business Data Analytics · Cost of Capital
Sundaram Textiles Ltd issues 10% irredeemable debentures of face value Rs 100 each at par. The company's tax rate is 25%. What is the after-tax cost of debt?
The after-tax cost of debt is 7.5%. Debentures issued at par carry a pre-tax cost equal to the 10% coupon, and interest is tax deductible, so the cost is reduced by the 25% tax rate: 10% multiplied by 0.75 gives 7.5%.
- A10.0%
- B7.5%Correct
- C12.5%
- D2.5%
Explanation
For irredeemable debentures issued at par, pre-tax cost = coupon/price = 10/100 = 10%. After-tax cost = 10% x (1 - 0.25) = 7.5%. Choosing 10% ignores the tax shield on interest.
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