MST531: Cost of Debt and Preference Share

Lecture 19
 Cost of Redeemable Debt
•Debt Issued at Par INT
kd  i 
B0
•Debt Issued at Discount or Premium
n INTt Bn
B0   
t 1 (1  k ) (1  kd )
t n
d

Where Bn is maturity value

•Tax adjustment
After-tax cost of debt  kd (1  T )
 Cost of Redeemable Debt
Short-cut method to calculate kd :

(𝑩𝒏 − 𝑩𝟎)
𝑰𝑵𝑻 +
𝒌𝒅 = 𝒏
𝟎. 𝟔𝑩𝟎 + 𝟎. 𝟒𝑩𝒏
 Cost of Redeemable Debt
Illustration-4:
A company issued 5 year 11%
redeemable bonds of Rs. 2,00,000
(Rs 100 face value) at a discount of
15%. The bond is sold at a premium
of 5% after 5 years. If the tax rate is
35%, calculate the cost of debt.
 Cost of Redeemable Debt
Short-cut method to calculate kd :

Here
INT = Rs 100*0.11 = Rs 11,
B0 = Rs 100*(1-0.15) = Rs 85,
Bn = Rs 100*(1+0.05) = Rs 105,
n =5
 Cost of Redeemable Debt
Short-cut method to calculate kd :

(𝟏𝟎𝟓 − 𝟖𝟓)
𝟏𝟏 +
𝒌𝒅 = 𝟓
𝟎. 𝟔 ∗ 𝟖𝟓 + 𝟎. 𝟒 ∗ 𝟏𝟎𝟓

= 𝟏𝟔. 𝟏𝟑%
After tax cost = 16.13*(1-0.35)= 10.48
 Cost of Preference Capital
•Irredeemable Preference Share
PDIV
kp 
P0

•Redeemable Preference Share

n PDIVt Pn
P0 =  +
t 1 (1  k ) (1  k p )
t n
p
 Cost of Preference Capital
Where
kp = Cost of preference share
PDIV = Expected dividend on shares
P0 = Issue price of preference share
Pn = Maturity value of share
•India does not float Irredeemable
Preference Shares
Cost of Redeemable Preference Share
Short-cut method to calculate kp :

(𝑷𝒏 − 𝑷𝟎)
𝑷𝑫𝑰𝑽 +
𝒌𝒑 = 𝒏
𝟎. 𝟔𝑷𝟎 + 𝟎. 𝟒𝑷𝒏
Cost of Redeemable Preference Share
Illustration-5:
A company issued 10 year 11%
redeemable Preference Shares of
Rs. 10,000 (Rs 100 face value) at a
discount of 15%. Shares get matured
at a premium of 5%. If the floatation
cost is Rs 2 per share, calculate the
cost of preference capital.
Cost of Redeemable Preference Share
Short-cut method to calculate kp :
Here
PDIV = Rs 100*0.11 = Rs 11,
Net Proceeds= Face Value-Discount-Floatation Cost

P0 = Rs (100-15-2) = Rs 83,
Pn = Rs 100*(1+0.05) = Rs 105,
n = 10
Cost of Redeemable Preference Share
Short-cut method to calculate kp :

(𝟏𝟎𝟓 − 𝟖𝟑)
𝟏𝟏 +
𝒌𝒅 = 𝟓
𝟎. 𝟔 ∗ 𝟖𝟑 + 𝟎. 𝟒 ∗ 𝟏𝟎𝟓

= 𝟏𝟒. 𝟑𝟖%
Thank you

Prof. Narinder Verma

School of Business Management and Liberal Arts
Shoolini University
Village Bajhol, Solan (H.P)

+91 9816080528
narinderverma@shooliniuniversity.com