Question
A firm issues debentures of ₹10,00,000 at 10% coupon
rate, redeemable after 5 years at 5% premium. Flotation cost = 2%. Calculate effective cost of debt (Kd) before tax.Solution
Net proceeds = 10,00,000 – 2% = ₹9,80,000. Annual interest = ₹1,00,000. Redemption = ₹10,50,000. Kd ≈ [I + (RV – NP)/n] ÷ [(RV + NP)/2] = [1,00,000 + (10,50,000 – 9,80,000)/5] ÷ [(10,50,000 + 9,80,000)/2] = [1,00,000 + 14,000] ÷ 10,15,000 = 1,14,000/10,15,000 = 11.24%
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