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    FM Bapi Chowdhury

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    FM Bapi Chowdhury

    Uploaded by

    morerich.in
    6 views11 pages

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    Fm Bapi Chowdhury

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    6 views11 pages

    FM Bapi Chowdhury

    Uploaded by

    morerich.in

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
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    Explain the concept of Cost of Debt with

    suitable examples
    Programme- Bachelor of Business Administration
    Course code - BBAC403
    Course name - Financial Management
    Name- Bapi chowdhury
    Student code- BWU/BBA/22/007
    Section- A
    COST OF CAPITAL
    It is the rate that suppliers of funds expect to get. It is determined by the cost of the various
    sources of finance.

    James C. Van Horne: The cost of Capital is “a cut-off rate for the allocation of capital to
    investments of projects. It is the rate of return on a project that will leave unchanged
    the market price of the stock”.

    Importance
    Capital budgeting decisions

    Evaluation of final Performance

    Capital structure decisions


    Components of Cost of Capital
    Cost of Debt Cost of Equity

    Cost of Preference Share Cost of Retained


    COST OF DEBT (Kd)

    The cost of debt refers to the effective interest rate or the total
    amount of interest paid on any liabilities, such as bonds and loans.

    Perpetual / Irredeemable debt Cost of Redeemable Debt


    Perpetual / Irredeemable debt

    Irredeemable debt is that debt which is not required to be repaid during the lifetime of the company. A
    firm may issue perpetual bonds or it may have a policy of having a fixed amount of debt in the
    capital structure. In the case, when the old debt is repaid, it would be replaced by a new debt of same
    amount. In such a case debt is regarded as perceptual debt.

    Kd = I/NP ( 1 − t)

    Where,

    I – Interest payment

    NP - Sale price of bond or debenture

    t – Tax rate
    Cost of Redeemable Debt

    Redeemable debt is a debt which is repayable back to the lender by


    the borrower within the specific period. Redeemable debt has a fixed
    maturity date.

    Kd = I(1−t)+ (RV−NP)
    n
    RV+NP
    2
    Where
    I = Annual Interest charges
    t = Tax rate
    n = Number of years
    RV = Redeemable value of the debt at the time of maturity.
    NP = Net sale proceeds from the issue of debt
    Example of Irredeemable debt

    I – Interest payment = 500000*6% = 30000

    Interest rate = 6%

    NP - Sale price of bond or debenture = 450000

    t – Tax rate = 0%

    Kd = I/NP ( 1 − t)

    = 30000/450000
    = 0.067
    = 0.067*100
    = 6.7%
    Example of redeemable debt

    I = Annual Interest charges = 1000000*8% = 80000


    Interest rate = 8%
    n = Number of years = 5
    RV = Redeemable value of the debt at the time of maturity = 1000000+(1000000*10%) =
    1100000
    NP = Net sale proceeds from the issue of debt = 1000000

    Kd = I(1−t)+ (RV−NP)
    n
    RV+NP
    2
    = 80000+(1100000-1000000/5)/(1100000+1000000/2)
    = 80000+20000/10,50,000
    = 0.095*100
    = 9.5%
    conclusion

    Understanding the cost of debt is a critical concept in finance that represents the
    minimum returns investors expect for providing debt financing. It is essentially the
    effective interest rate that a borrower pays on loans and bonds. For companies,
    comprehending the cost of debt is essential in determining their capital structure,
    while for investors, it helps them assess the risk-reward profile of potential
    investments.
    Resources
    www.investopedia.com

    homework.study.com

    due.com

    economictimes.indiatimes.com

    www.iciciprulife.com
    Thank you

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