Calculating the cost of debenture. Question found in KNEC past papers with answer below.
Question: A company intends to raise extra finance using a 20% debenture. The corporation tax rate is 30%. Calculate the cost of the debenture.
Answer:
The cost of the debenture can be calculated as an after-tax cost of debt, which is established after accounting for the tax shield provided by interest expense as follows:
Cost of debenture = interest rate of the debenture × (1 – Tax rate)
Cost of debenture = 20% × (1-30%) = 20%*0.70
Cost of debenture = 14%
