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A company issues 10% debentures of Tshs100 at 10% premium, redeemable at par after 5 years. The company’s tax rate is 30%. Determine the cost of debt. The answers are different when tax is accounted for in interest and different when you find before tax of debenture and then multiply tax
when tax is multiplied of interest
Cost of debenture (Kd) =(I (1- t) +(RV-NP/n)) / (RV+NP/2)ANSWER = 4.76%
When before tax of debenture is multiplied to tax
Cost of debenture (Kd) =(I +(RV-NP/n)) / (RV+NP/2) * (1 – t)ANSWER =5.33%
With redeemable debt, the interest is tax allowable but the redemption is not tax allowable.
So the post-tax cost of debt does not equal the pre-tax cost of debt x (1 – T).This is all explained in my free lectures.
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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