Page 113 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes
DF PV of Cash Outflows ( )
Year Cash outflow ( )
7% 10% 7% 10%
1 - 7 8.25 5.389 4.868 44.96 40.16
7 100 0.623 0.513 62.30 51.30
PV of cash out flows 106.76 91.46

(-) PV of Cash inflows 97.00 97.00
9.76 5.54
Cost of debenture capital lies between 10 per cent and 12 per cent, because net present value 97
lies between the PV of 10 per cent and 12 per cent. Exact cost can be computed only with
interpolation formula:
 LDFPV  NP 
K = LDF+    HDF- LDF  LDFPV  HDFPV  
d
Where,
LDF = Lower discounting factor.

HDF = Higher discounting factor.
LDFPV = Lower discounting factor present value.
HDFPV = Higher discounting factor PV.
PVCIF = Present value of cash inflows
NP = Net proceeds.
 106.76 – 97 
K = 7%+ 3× 

d  106.76 – 91.46 
= 7%+ 1.91 = 8.91%
Short cut method
 I 1 – t + /N
 f+d+ p – p
K = r i m
p
RV+ NP /2
Where,
I = Interest
t = Tax rate
f = Flotation cost

d = Discount
p = Premium on redemption
r
p = Premium on issue
i
RV = Redeemable value
NP = Net proceed
N = Maturity period of debt
m
 3 – 0 +0 – 0 /7
15 1– 0.45 + 
K =
p
100 – 97 /2
8.68
K = = 8.81%
p
98.5

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