Question

Cost of irredeemable debt Sakthi Ltd. Issued 20,000 8% debentures of Rs.100 each on 1st April 2009. The cost of issue was Rs. 50,000. The company’s tax rate is 35% Determine the cost of debentures ( before as well as after tax) if they were issued, (a) at par; (b) at a premium of 10% and (c) at a discount of 10%.​

Answer 1

We are required to determine the cost of debentures when they are issued at (a) par, (b) premium, and (c) discount.

The cost when debentures are issued at par is $8.21$%

The cost when debentures are issued at a premium is $7.44%$%

The cost when debentures are issued at discount is $9.14$%

$COST OF CAPITAL$ (Kp )$=$ $\frac{Annual Preference dividend}{Net proceeds}$

When the debentures are issued at par the formula is: $NP=Face value - Issue expenses$

Face Value = $20000 X 100$ = $2000000$

Issue expenses = $50000$

(a) Net Proceeds = $2000000 - 50000$

                     $= 1950000$

Annual Preference Dividend = $160000$

Cost of capital = $\frac{160000}{1950000}$ × $100$

                       $= 8.21%$%

(b) Premium of $10$%

Net Proceeds = $Face value + Premium - Issue expenses$

                       $= 1950000+ 200000$

                       $= 2150000$

 Cost of capital = $\frac{160000}{2150000}$ × $100$

                          $= 7.44$%

(c) Discount of $10$%

$Net proceeds = Face value - Discount - Issue expenses$

                        $= 1950000- 200000$

                        $= 1750000$

Cost of capital $= 9.14%$%

Therefore, the cost of capital when debentures are issued at par, premium, and discount are $8.21%,$%, $7.44$%, and $9.14$% respectively.

PROJECT CODE: #SPJ2