How to find Kd

If debt is irredeemable
then Cost of Debt :
Kd = i/Po
i interest amount
Po current market price of debit

example
A ltd has 8% debenture at a par value of 100 . Tax rate is 30% and market price of
debenture is 80.
Required:
1 Cost of debt
2 After tax cost of debt

1 Kd 10%

2 Kd (1-t) 7%

Example
A ltd has 7% debenture at a par value of 100 and market price of debt debenture is 35 .
tax rate is 30.
Required :
1 Cost of debt
2 After tax Cost of debt

Irredeemable Debt
1 Kd 20%
2 Kd 14%

In irredeemable debt , sometimes interest is not paid annually

Then Cost of debt :
Kd = ( 1 + i/Po)^n -1

i interestpaid each time

n no of time interest is paid in a year
Po market price of debt

Example
A ltd has 8% debenture at a par value of 100 and market price of 80.
tax rate is 30% and interest is paid half yearly.
Required:
1 Cost of debt n 2
2 After tax Cost of debt i 4
po 80
We not us the formula Kd = i/Po
Instead we use the 2nd formula : Kd = ( 1 - i/Po)^n -1

1 Kd 10.25% 10.25%

2 Kd 7.175%

A ltd has 6% debenture at a par value of 100 and market price of 70. Tax rate is 30%
and interest is paid quarterly.
Required: Cost of debt n

Kd 8.85% 1.5
after tax
Kd 6.20%

1 Question
A ltd has 8% debenture at a par value of 100 is redeemable after 7 years at par.
Tax rate is 30% and market price of debt is 105 .
Find cost of Debt after tax

0 1 to 6 7
Market price -105 A
Interest 5.6 5.6 a
Redeemed 100 B
NCF -105 5.6 105.6 b
DF 6% 1 4.917 0.665
PV -105 27.5352 70.224 Kd ( redemmable)
NPV -7.24079999999999
DF 3% 1 5.417 0.813
PV -105 30.3352 85.8528
NPV 11.188

2 Question
A ltd has 10% preference shares at a par value of 2 and market price of 4.
Tax rate is 30%
Find Cost of preference shates
 Kp 5.00%

3 Question
A ltd has 9% debentures at a par value of 100 to be redeemed after 5 years at par
it can also be converted after 5 yrs into 15 shars . Share price at that time will
be 7 per share . Market price of debt is 104. Tax rate is 30%
Find after tax cost of debt.

0 1 to 4 5
Market value -104 6.30%
Interest 6.3% 6.3 6.3
Redeem 100

0 1 to 4 5
Market value -104
Interest 6.3% 6.3 6.3 A
Converted 105 a
NCF -104 6.3 111.3 B
DF 6% 1 3.465 0.747 b
PV -104 21.8295 83.1411
NPV 0.9706 IRR

DF 12 % 1 3.037 0.567 Kp (convertible)

PV -104 19.1331 63.1071
NPV -21.7598

4 Question
Market price of a debt is 90 . Tax rate is 30% and debt pays interest of 7% at par of 100
Find after tax cost of debt.

Kd 7.78%
after tax Kd 5.44%

5 Question
A ltd has 12% debt at par value of 100 and market price of 80 . Tax rate is 30% .
and interest is paid every two months . Find cost of debt

Kd 15.97% n 6
 How to get Ke ?
Ke is the cost of equity i-e return paid to ordinary shareholders.

There are 2 models to find Ke :

1 Divident valuation model (DUM)
2 Capital asset pricing model (CAPM)

DUM
a model designed to find share price
Rearrange the formula
Po = D1 / (Ke - g ) Ke - g = D1/Po
Where as : Ke = D1/Po + g
D1 Next yrs divident
Ke Cost of equity
g growth rate
Po Current share price ex divident

Example
Current share price 8
Divident per share 0.6
Growth rate 10%
Required : Ke under DUM

Ke = D1/Po + g

g 10%
Po 8
D1 0.66

Ke 18.25%

1 Example
Market Price ex divident 10
Divident per share 2
Growth 5%
Requried:
Ke under DUM

Ke 26.00%

2 Example
Share price cum divident 12
 Divident per share 0.5 D1 0.575
Growth 15% po 11.5
Required g 15%
Ke under DUM

Ke 20.00% 11.5

3 Example
Share Price CUM divident 5.6
Share price ex divident 5
Growth 10%
Required
Ke under DUM

solution
Share price 0.6

Ke 23.20%

Sometimes g is not given

Gordon's retension model

g=b*r
b Retention ratio
r return on equity

Ret = 1 - payout rates

Payout rates = Divident per share / EPS

Example
Share price 12 Example
Divident per share in last few yrs Shareprice
20x2 0.8 Divident share
20x3 0.82 EPS
20x4 0.85 Return on Equity
Required Required
Ke under DUM Ke under DUM

g 3.08% g=b*r
r
Ke 10.3% b

g 22.50%

Ke 30.2%
ture is 35 .

10.3%
 n 4
i 1.5
po 70

8.9%

Saray inflows and outflows ko layn gai aur IRR find karin gay disounted karin gay debt ka sath jo perc

5.6%
11.188
3%
-7.24079999999999
6%

( redemmable) 4.8%
 0.97059999999999
6%
-21.7598
12%

6.26%

(convertible) 6.26%

0.159693

i 2 po 80
arrange the formula

= D1/Po + g

20.0%
Past divident model
g = (latest divident / earliest divident )^1/n - 1

8
0.5
2
30%

30%
75%
n gay debt ka sath jo percentage hoti hai us ko after tax ker ka .