A company issues 11% debentures of ₹ 100 each for an amount aggregating ₹ 2,00,000 at 10% premium, redeemable at par after 5 years. The company tax rate is 40%. The cost of debt is:
4.38%
The after-tax cost of redeemable debt combines the tax-adjusted interest with the amortised premium or discount over the life of the debenture, relative to the average of its redemption value and net proceeds. The formula is \(K_d = \dfrac{I(1-t) + \frac{RV - NP}{n}}{\frac{RV + NP}{2}}\).
Set up the figures per debenture of face value ` 100. The coupon interest is \(I = 11\) (11% of 100). It is issued at a 10% premium, so the net proceeds are \(NP = 110\). It is redeemable at par, so the redemption value is \(RV = 100\). The life is \(n = 5\) years and the tax rate is \(t = 0.40\).
Now compute the parts. After-tax interest is \(11(1 - 0.40) = 6.6\). The amortised premium is \(\frac{100 - 110}{5} = -2\) (a premium reduces the effective cost). The numerator is \(6.6 + (-2) = 4.6\) and the average investment (denominator) is \(\frac{100 + 110}{2} = 105\).
Therefore \(K_d = \dfrac{4.6}{105} = 0.0438\), that is about 4.38%. Hence the cost of debt is 4.38%.
Similar Questions
A public works project is proposed that has total present-worth benefits of ₹ 75 million and total present-worth cost of ₹ 55 million. In deliberating this proposal, some members of the Municipal Board have suggested that the project has a total present-worth disbenefits of ₹ 15 million; other members feel that ₹ 15 million should be treated as a cost. What will be the benefit cost ratio and net benefits value while considering the disbenefits as a cost?
Select the correct statement/s from the following :
Statement I : The slope of the NPV profile reflects how sensitive the project is to discount rate changes.
Statement II : To find total NPV of more than one projects, their NPV cannot be added.
Statement III : The certainty equivalent coefficient applies adjustments to both, the cash flows (in the numerator) and the discount factor (in the denominator).
Statement IV : The risk - adjusted discount factor applies adjustment for risk only to the discount factor (denominator).
Codes :
Indicate the correct code for the combination from the following regarding the superiority of the wealth maximisation over the profit maximisation objective of the financial management :
(a) It takes into account long term stability and survival of the firm.
(b) It takes care of all other objectives of the firm like exploring and expanding markets, etc.
(c) It is based on the assumption of perfect competition in the market.
(d) It considers risk alongwith returns.
Code :
Capital budgeting is concerned with :
Which combination of the following statements about the net present value method of the investment project appraisal is correct ?
(a) It considers all the cash flows from the project
(b) It gives more weightage to distant flows than near-term flows
(c) It considers the time value of money
Code :
In which of the following appraisal criteria of capital budgeting, the use of varying opportunity cost of capital as a discount factor is possible ?
(a) NPV
(b) IRR
(c) Pay-back Period
(d) ARR
Select the correct statement/s from the following:
Statement I: The slope of the NPV profile reflects how sensitive the project is to discount rate changes.
Statement II: To find total NPV of more than one projects, their NPV cannot be added.
Statement III: The certainty equivalent coefficient applies adjustments to both, the cash flows (in the numerator) and the discount factor (in the denominator).
Statement IV: The risk-adjusted discount factor applies adjustment for risk only to the discount factor (denominator).
Codes:
Statement – I : In general, the NPV and IRR methods lead to the same acceptance or rejection decision when a single project is involved.
Statement – II : The inconsistency in ranking of competing projects as per the NPV and IRR methods lies in the implicit assumptions with regard to different rates of returns on re-investment of intermediate cash flows.
Code :
Under the Modified Accelerated Cost Recovery System (MACRS) an asset in the “5 year property class” would typically be depreciated over how many years ?
In case the firm makes varying investments on the different investment projects, the appropriate project evaluation technique would be, which one of the following?
Important Questions from Capital Budgeting
- Assume B is social benefits, C is social costs, r is the social discount rate, t is the time and T is the life of the investment project. The Net Present Value (NPV) of a project is
- In certainty-equivalent approach, risk adjusted cash flows are discounted at
- Statement - I : In payback period method, the risk of the project is adjusted by lessening the target payback period.
Statement - II : Sensitivity Analysis helps in calculation of net present value of the proposal.
Code : - Which one of the following equates the present value of cash out flows and the present value of expected cash inflows from a project ?
A public works project is proposed that has total present-worth benefits of ₹ 75 million and total present-worth cost of ₹ 55 million. In deliberating this proposal, some members of the Municipal Board have suggested that the project has a total present-worth disbenefits of ₹ 15 million; other members feel that ₹ 15 million should be treated as a cost. What will be the benefit cost ratio and net benefits value while considering the disbenefits as a cost?
