Question

Ten years ago, God’sway Ltd issued GH¢2.5 million of 6% discounted debenture at GH¢98 per GH¢100 nominal. The debentures are redeemable in 6 years from now at a GH¢2 premium over nominal value. They are currently quoted at GH¢79 per debenture, ex interest. The company pays tax at the rate of 30%. Required: Estimate the after tax cost of the debenture.

Answer 1

Given face value=2.5 million=2500000

First we have to find the before tax cost of debt using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

nper=number of periods remaining to redeem =6

pmt=annual coupon payment=(6%*face value)=(6%*2,500,000)=150,000

pv=present value of bond=79%*2500000=1975000

fv=redeems at 102%*face value=102*2500000=2550000

=RATE(6,150000,-1975000,2550000,0)

RATE=11.25%= before tax cost of debt

After tax cost of debt= before tax cost of debt*(1-tax rate)=11.25%*(1-30%)=7.88%