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Sir, Why do we take average cost while computing Kd for irredeemable debentures. While for redeemable debentures we take only the Net Proceed as cost . By average cost I mean the average of net proceeds and redemption value. Can anyone explain the logic.

Answers (2)

We take average of RV & NP for redeemable not irredeemable. The cost of debt is merely the interest rate paid by the company on its debt. However, since interest expense is tax-deductible, the debt is calculated on an after-tax basis. Thus it is the return expected by debenture holders for the money they put in. In irredeemable debentures, we dont repay any amount to the debenture holders . But in redeemable debentures the amount we pay interest during the period and also redeemable value at the end of the term, thus the numerator has both the returns expected by debenture holders. Now the denominator should have what the debenture holder's money with the company , at the beginning the issue value and at the end redemption value thus the average

sudha reddy Moderator

We take average of RV & NP for redeemable not irredeemable. The cost of debt is merely the interest rate paid by the company on its debt. However, since interest expense is tax-deductible, the debt is calculated on an after-tax basis. Thus it is the return expected by debenture holders for the money they put in. In irredeemable debentures, we dont repay any amount to the debenture holders . But in redeemable debentures the amount we pay interest during the period and also redeemable value at the end of the term, thus the numerator has both the returns expected by debenture holders. Now the denominator should have what the debenture holder's money with the company , at the beginning the issue value and at the end redemption value thus the average

Thanks.Sorry for the error in question. You got my question right. But a small clarification, is it since the numerator has both the interest and premium or loss on redemption aspect that makes one include both the net proceeds and redemption values average in the denominator. As , the actual cost incurred by the debenture holder is only the issue price.