Question

Cost of Capital for Bonds and, Debentures is calculated on:

• A. Before Tax basis
• B. After Tax basis
• C. Risk-free Rate of Interest basis
• D. None of the above

Answer 1

Answer: (B)

After Tax basis

Interest is a tax deductible expenses and charged to profit & loss account. Therefore, cost of capital for debentures , bonds is calculated after tax basis.

For example, a company issue 10% debenture of Rs.80 with a corporate tax rate of 30%. Cost of debt would be calculated as:

Kd= i(1-t)/P

Kd= Cots of debt

i=Interest cost

t=tax rate

P= value of debenture

Therefore:

Kd=10(1-.30)/80

Kd=10*.7/80

Kd=0.0875 i.e.8.75%