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

Tanvi Industries has a 10% irredeemable debenture issue of Rs 5,00,000 (face value Rs 100 each) issued at par. Flotation costs are 5% of the issue price and the tax rate is 25%. What is the after-tax cost of debt (to nearest two decimals)?

The after-tax cost of debt is 7.89%. Net proceeds after 5% flotation cost are Rs 95 per debenture, annual interest is Rs 10, and the tax shield reduces it to Rs 7.50. Dividing 7.50 by 95 gives 7.89%.

  1. A7.50%
  2. B7.89%Correct
  3. C10.53%
  4. D9.50%

Explanation

Net proceeds per debenture = 100 - 5 = Rs 95. Interest = Rs 10. Kd (after tax) = 10 x (1 - 0.25) / 95 = 7.5/95 = 7.89%. 7.50% ignores flotation costs; 10.53% is the pre-tax cost 10/95.

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