Calculation Cost Of Capital Bonds Debentures

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The calculation of  cost of capital of bonds and debentures i.e., cost of debt , involves relatively simple procedure and is subject to the terms and conditions relating to the rate of interest, timings of interest payment and repayment amount etc., The cost of capital for debt may be defined as the returns expected by the potential investors of debt securities of the firm. In order to find out the cost of capital of debts, the following information is required:

a)    Net proceeds from the Issue:

This refers to the net cash inflow at the time of issue of debt.
This can be calculated  as

                    Bo  =   FV + Pm – D – F

              Where    Bo  =  Net  Proceeds
                             FV  =  Face value of Debt
                            Pm  =  Premium charged on the issue of debt
                               D  =  Discount allowed at the time of issue of debt
                               F  =  Flotation cost i.e., the cost of raising funds ( including ) underwriting
                                        brokerage and issue expenses.          

b)    Periodic Payments of Interest :

In most cases, (except in case of issue of Zero interest fully convertible debentures), the firm has to pay interest on debt instruments. To simplify the calculation of cost of debt, the interest amount is assumed to be payable annually. It may be noted that interest on debt is always payable on the face value irrespective of the issue price. Sometimes the bonds and debentures as well as loans from financial institutions require regular repayments of the principal amount also. This periodic amortization of the principle amount is also considered as a cash outflow together with interest payment for a particular year.

c)    Maturity payments :

The principal amount of the debt instruments or loan (i.e., the balancing figure after amortization, if any ) will be payable by the firm on the maturity date. This may be paid together with the interest for the last year.           

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