Cost of Redeemable Debt

Cost of Redeemable Debt Formula

Cost of redeemable debt is calculated with the help of IRR formula (Internal Rate of return). The formula of IRR has given below

Formula = L +(NPV_L/NPV_H-NPV_L)x (H-L)

R_L= Lower rate of Return

R_H= Higher Rate of Return

NPV_L = NPV with Lower rate of Return

NPV_H= NPV at higher rate of return

Cost of irredeemable debt process has been explained by example;

ABC & Co Quoted	102
Coupon Rate	10%
Tax rate on companies	30%
Maturity	5 years

       Solution

Particulars	Value	Dis. 5%	PV @ 5%	Dis. 10%	PV @ 10
Market Value	102	1	102	1	102
Interest	(7)	4.329	(30.30)	3.791	(26.53)
Redemption Value	(100)	.784	(78.40)	.621	(62.1)
			(6.7)		13.37

      Formula = L +(Nl/Nh-Nl)x (H-L)

      = 5% + (6.7/20.07)(5%)

      =.05+.323(.05)

      =6.65%

Cost of irredeemable Debt

Cost of irredeemable Debt

Irredeemable debt is never paid pack (theoretical concept). Cost of irredeemable debt is calculated by the following formula

Io ( 1-T)/Po

Where,

Io= Interest rate

T= Tax Rate

Po= Market value of debt (Ex interest Price)

 Example

Rate of interests = 9%

Value of Debt= 120

Tax Rate =30%

Solution

Io ( 1-T)/Po

= [ 9(1-30%)]/120

=6.3/120

=5.25% (cost of Debt)

CAPM Formula

CAPM Formula

Cost of equity can be calculated by the CAPM (Capital Asset Pricing Model).This methods takes into account market risk.

CAPM = Rf + βe (Rm-Rf)

Rf= Risk Free Rate

Rm= Market Rate

βe = Equity Beta

Example

Market Rate= 9%

Bank Rate= 12%

Equity Beta= 1.3

Calculate Cost of equity?

Solution

=  12% + 1.3 ( 12%-9%)

=12%+3.9%

=15.9%