Cost of Debt.

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Presentation transcript:

Cost of Debt

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 = ------ --------- 15% SV 1,00,000

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

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%

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

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?

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

Determination of PV at 10% & 11% rates of interest. The value would be 11% Year Cash Outflow PV @ 10% PV@ 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

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

I(1+t)+(f+d+Pr-Pi/Nm) Kd= ------------------------------- (RV+SV)/2 150(1-.35)+(50+25/10) (925+1000)/2 = 97.5 + 7.5/962.5 =10.91

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

I(1+t)+(f+d+Pr-Pi/Nm) Kd= ------------------------------- (RV+SV)/2 15(1-.35)+(-10/5) (110+100)/2 =7.75/105 7.38% This method is not applicable when the principal is repaid in a number of installments‘.

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.

Net Proceeds= 1,00,000-5% =Rs.95,000 Year Cash outflow Principal Interest adjusted with tax Total outflow PV @ 11% PV @12% 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