Question

In: Finance

Ten years ago, God’sway Ltd issued GH¢2.5 million of 6% discounted debenture at GH¢98 per GH¢100...

Ten years ago, God’sway Ltd issued GH¢2.5 million of 6% discounted debenture at GH¢98 per
GH¢100 nominal. The debentures are redeemable in 6 years from now at a GH¢2 premium over
nominal value. They are currently quoted at GH¢79 per debenture, ex interest. The company
pays tax at the rate of 30%. Required: Estimate the after tax cost of the debenture.

Solutions

Expert Solution

Kd        = (1-t)*{I+[(RV-NP)/n]} *100
[(RV+NP)/2]
where,
Kd        = Cost of Debt
I           = Amount of Interest
t         = Tax rate
RV      = Redemption Value i.e. Face Value + Premium on Redemption
NP     = Net Proceeds i.e. Face Value - Discount on Issue
n        = Period of Debt
Thus, we substitute given values in the above formula, as follows -
Kd        = ?
I           = 25000 debentures*$100 par value*6% interest p.a. = $ 150,000
t         = 30%
RV      = 25000 debentures*($100 par value+$2 premium) = $ 25,50,000
NP     = 25000 debentures*($100 par value-$2 premium) = $ 24,50,000
n        = 6 years
Kd        = (1-.30)*{150,000+[(25,50,000-24,50,000)/6]} *100
[(25,50,000+24,50,000)/2]
Kd        = 4.667%

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