1. Cost of Debt

2. 1. (YTM) Cost of Perpetual Debt
A company has 15% perpetual debt of Rs.1,00,000. The tax rate is 35%. Determine the cost of capital(before tax & after tax). Assuming the debt is issued at 1. Par 2.10%discount 3.10% premium. 1.Debt issued at par: I 15,000 Before tax Ki = % SV 1,00,000

3. After tax cost of debt:
Kd = Ki (1-t)
= 15%(1-.35)
= 9.75%

4. 2. Debt issued at discount 15,000 Ki = ----------- = 16
2. Debt issued at discount 15,000 Ki = = 16.7% 90,000 Kd = 16.7%(1-.35) 10.85%

5. 2. Debt issued at premium
15,000
Ki = = 13.6%
1,10,000
Kd = 13.6%(1-.35) 8.8%

6. 2. Cost of Redeemable Debt
A company issues a new 15% debentures of Rs.1, 000 face value to be redeemed after 10 years. The debenture is expected to be sold at 5% discount. It will also involve floatation costs of 2.5% of face value. The company’s tax rate is 35%. What would be cost of debt?

7. 1. Trial and Error Method
Market price = Face value- (Discount +Floatation cost)
= 1000-(50+25)
=925
Interest = 150, t=35%, = 150 (1-.35)
= 97.5
The value of Kd can be obtained as in the case of IRR by trial & error

8. Determination of PV at 10% & 11% rates of interest.
The value would be 11%
Year
Cash Outflow
10%
11%
Total
10%
Total 11%
1-10
97.5
6.145
5.889
599.14
574.18 10
1000
.386
.352
386
352
985.14
926.18

9. 2. Short cut method I(1+t)+(f+d+Pr-Pi/Nm)
Kd=
(RV+SV)/2
I= Interest Payment
Rv = Redeemable Value of debt
SV = Net proceeds (Face Value- Issue expenses)
Nm= term of Debt
F= Floatation cost
d= discount on issue of debentures
Pi = Premium on issue of debt
T= tax rate

10. I(1+t)+(f+d+Pr-Pi/Nm)
Kd=
(RV+SV)/2
150(1-.35)+(50+25/10)
( )/2
= /962.5
=10.91

11. A company issues 15% debentures of Rs
A company issues 15% debentures of Rs.100 for an amount aggregating Rs1,00,000 at 10% premium, redeemable at par after 5 years. The company’s tax rate is 35%. Determine the cost of debt using short cut method

12. I(1+t)+(f+d+Pr-Pi/Nm) Kd= ------------------------------- (RV+SV)/2
15(1-.35)+(-10/5)
( )/2
=7.75/105
7.38%
This method is not applicable when the principal is repaid in
a number of installments‘.

13. A company has issued 15% debentures aggregating Rs. 1,00,000
A company has issued 15% debentures aggregating Rs.1,00,000. The floatation cost is 5%. The company has repay the debentures at par in 5 equal annual installments starting at the end of year1. The company’s rate of tax is 35%. Find the cost of debt.

14. Net Proceeds= 1,00,000-5% =Rs.95,000 Year Cash outflow Principal
Interest adjusted with tax
Total outflow
11% 1
20,000
1,00,000*15/100
=15,000
15,000*.65
=9750
29,750
.901
.893
26,805
26,567 2
7,800
27,800
.812
.797
22,574
22,157 3
5,850
25,850
.731
.712
18,896
18,405 4
3,900
23,900
.659
.636
15,750
15,200 5
1,950
21,950
.593
.567
13,016
12,446
97041
94775