COST OF DEBT

MEANINGS
 COST OF DEBT
• Debt is loan
• Cost of debt can be of two types-
• 1.Pre Tax
• 2.After Tax
 Leaning outcome
1. To understand what is debt
2. To understand cost of debt
 News TODAY
Sitharaman had said the regime of paying
compensation to states for revenue shortfall
resulting from subsuming their taxes such as
VAT in the uniform national tax GST will end in
June next year
 Cost of Debt
• Example:
• Rupees 10 lac 10% Loan from Punjab National
Bank.
The company pays interest @10% on
Rs.10,00,000
Interest=Rs.1,00,000
 COST OF DEBT
Also company pays Tax @40%
Then; Interest of Rs.1,00,000 is deductible as
expenses
It means company gets tax advantage on
Rs.1,00,000
TAX ADVANTAGE
40% of Rs.1,00,000
Rs.40,000
 COST OF DEBT
Therefore cost of debt is-
a.Pre tax=10%(Rs.100000 on Rs.1000000)
b.After Tax=Rs.60,000(Rs.60,000 on
Rs.10,00,000)
 Cost of Debt
BEFORE TAX=Rate Given(10% in example)
AFTER TAX=DEBT RATE-TAX ADVANTAGE
Before Tax Rate(1-Tax Rate)
10%(1-40%)
10%(60%)
6%
 Tax Advantage(Loan Case)
• Income 2 50 000
Interest 1 00 000
(10% of 10 lac)
Taxable Income1 50 000 ---------------
Total 2 50 000 2 50 000
 Tax Advantage(Loan Case)
• Net income 1 50 000
• Tax 60 000
• Profit 90 000 ------------------------
1 50 000 1 50 000
 Tax Advantage(Equity Case)
• Income 2 50 000
Interest 0000000

Taxable Income2 50 000 ---------------

Total 2 50 000 2 50 000
 Tax Advantage(Equity Case)
• Income 2 50 000
• Tax 1 00 000
Profit 1 50 000 ----------------------------------------
Total 2 50 000 2 50 000
 Tax Advantage(Equity Case)
• Profit 1 50 000
• Dividend 100 000
Net Profit 50 000 ------------
1 50 000 1 50 0000
Tax Advantage(Equity Case versus Debt Case)

Compare
Profit Case Debt 90 000
Profit Case Equity 50 000
Difference 40 000
Why???
Tax Paid (Case Debt) 60 000
Tax Paid(Case Equity) 100 000
Difference(adv) 40 000
 Debt Cost Analysis
Debt Interest@10% 1 00 000
Less TAX ADV. 40 000
Net Cost 60 000
% Cost after tax ( 60 000/10 00 000)x100=6%
Equity is 10%
 MCQ

Debt Cost can be of

A.Pre tax
B.After tax
c.None
d.Both
 MCQ
Debt Cost can be of
A.Pre tax
B.After tax
c.None
d.Both
 MCQ
• TAX ADVANTAGE IS
• A.Debt Rate
• B.Tax Rate
• C.DEBT RATE(1-TAX RATE)
• D.NONE
 MCQ
• TAX ADVANTAGE IS
• A.Debt Rate
• B.Tax Rate
• C.DEBT RATE(1-TAX RATE)
• D.NONE
 MCQ
• After tax cost of debt is-
• A.DEBT RATE
• B.Tax rate
• C.DEBT RATE(1-TAX RATE)
• D.All of above
 MCQ
• After tax cost of debt is-
• A.DEBT RATE
• B.Tax rate
• C.DEBT RATE(1-TAX RATE)
• D.All of above