A company is considering, raising Rs. 100 lakh by one of the two alternative methods viz; 14 per cent institutional term loan and 13% non-convertible debentures. The term loan portion would attract no major incidental cost. The debentures would have to be issued at a discount of 2.5% and would involve Rs. 1,00,000 as cost of issue. Advise the company as to the better option based on the effective cost of capital in each case. Assume a tax rate of 35%.
Thanks in advance
anyone reply please its very urgent.
SInce there one missing figure of period for which debentures is issued, My answer will be changed when the period is given.So according to the given Ques. My Answer is
Cost of loan=9.1%
Cost of Debenture= 8.6%
So Debentures is the better option.
1. Cost of institutional loan=100 Lakhs*9.1%=910000
2. Cost of debentures=100 Lakhs*8.6%+100000 (Cost of issue of debenture)
860000+100000=960000
Here, the cost of issue of debenture is higher so, institutional loan should be raised.
Query- Is it correct to consider cost of issue of debenture while calculating the total cost of debenture? If no, please provided the reason for the same.
In my previous answer i have already considered the amount of Rs 100000. so u should not to take again.Exactly cost of issue of debdnture is the part of cost to debentures.
why the answer is different? Please show you calculations.
Harish,
When you find out the cost of debentures you already consider the effect of the cost of issue in the denominator( i.e NET PROCEEDS as it will be 100 lakhs less disc and cost of issue)..So there is no need to add back that again
but, how i mean i have just deducted the discount and net proceeds comes out is 100-2.5=97.5
I have not considered 100000 while calculating cost of debenture.
Cost of Term Loan = 9.1% (10000000*14(1-0.35)%) / 10000000
Cost Of Debentures = 8.535% (10000000*13(1-0.35)%) / 9900000
So debenture is the better option
CAclubindia
