Question

Which of the following cost of capital require tax adjustment?

• A. Cost of Equity Shares
• B. Cost of Preference Shares
• C. Cost of Debentures
• D. Cost of Retained Earnings

Answer 1

The correct option is C Cost of Debentures

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%