Question

ABC co. issued 5,000 ten years 8% debentures of Rs.100 each at par redeemable at 5% premium. The cost of issue is 2%. The cost of debt capital is:​

Answer 1

Answer:

The cost of debt capital for ABC Co. is 0.57%.

Explanation:

The cost of debt capital can be calculated by considering various factors involved in the issuance of debentures.

In this case, ABC Co. issued 5,000 ten-year 8% debentures of Rs.100 each at par redeemable at a 5% premium. The cost of the issue is 2%.

To calculate the cost of debt capital, we need to consider the following components:

Coupon Interest Payments: The debentures carry an 8% coupon rate, which means ABC Co. will pay an annual interest of 8% of the par value of each debenture. Therefore, the annual coupon interest payment per debenture is 8% of Rs.100, which is Rs.8.

Premium Redemption: The debentures are redeemable at a 5% premium, which means ABC Co. will have to repay Rs.105 for each debenture at the time of maturity.

Cost of Issue: The cost of the issue is 2%, which represents the expenses incurred by ABC Co. in issuing the debentures, such as underwriting fees, legal expenses, and administrative costs.

To calculate the cost of debt capital, we can use the following formula:

Cost of Debt Capital = (Coupon Interest Payments + Premium Redemption - Cost of Issue) / (Par Value + Premium)

Let's calculate the cost of debt capital:

Coupon Interest Payments = 8% of Rs.100 = Rs.8

Premium Redemption = 5% of Rs.100 = Rs.5

Cost of Issue = 2% of (5,000 debentures * Rs.100 par value) = Rs.10,000

Par Value = 5,000 debentures * Rs.100 = Rs.500,000

Premium = 5,000 debentures * Rs.5 = Rs.25,000

Cost of Debt Capital = (8,000 + 5,000 - 10,000) / (500,000 + 25,000)

= 3,000 / 525,000

= 0.0057 or 0.57%

Therefore, the cost of debt capital for ABC Co. is 0.57%.

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