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

Tulsi Industries Ltd. issues perpetual debentures of Rs 1,00,000 face value carrying 10% interest, issued at par with no flotation cost. The tax rate is 25%. What is the after-tax cost of this debt?

The after-tax cost of debt is 7.5%. Interest is tax deductible, so the effective cost equals the 10% coupon multiplied by one minus the 25% tax rate. The 10% figure ignores the tax shield, while 2.5% is only the tax saving.

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

Explanation

After-tax cost of debt = Interest rate x (1 - tax rate) = 10% x (1 - 0.25) = 7.5%. Option 10.0% ignores the tax shield on interest. Option 12.5% wrongly divides by (1 - t) instead of multiplying, and 2.5% is the tax saving only.

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