A company issues: 15% convertible debentures of 100 each at par with a maturity period of 6 years. On maturity, each debenture will be converted…

CA Intermediate · Financial Management and Strategic Management · MTP · September 2025
A company issues: 15% convertible debentures of 100 each at par with a maturity period of 6 years. On maturity, each debenture will be converted into 2 equity shares of the company. The risk-free rate of return is 8%, market risk premium is 16% and beta of the company is 1.20. The company has paid dividend of 13.38 per share. Five years ago, it paid dividend of 10 per share. Flotation cost is 6% of issue amount.5% preference shares of 100 each at premium of 10%. These shares are redeemable after 10 years at par. Flotation cost is 5% of issue amount. Assuming corporate tax rate is 40%. (i) CALCULATE the cost of convertible debentures using the approximation method. (ii) Use YTM method to CALCULATE cost of preference shares.

Suggested Answer and Working Notes:

3. (a) (i) Calculation of Cost of Convertible Debentures: Given that, Rf = 8% Rm - Rf = 16% β = 1.20 D0 = 13.38 Dividend 5 years ago = 10 Flotation Cost = 6% Using CAPM, Ke = Rf + β (Rm - Rf) = 8% + 1.20 (16%) = 27.20% Calculation of growth rate in dividend 13.38 = 10 (1+g) 5 1.338 = (1+g) 5 g = 6% Price of share after 6 years = D 7 / (Ke - g) = 13.38 (1.06) 7 / (0.272 - 0.06) = 13.38 x 1.504 / 0.212 P 6 = 94.92 Redemption Value of Debenture (RV) = 94.92 × 2 = 189.84 (RV) NP = 94 n = 6 Kd = [Int(1-t) + (RV-NP)/n] / [(RV+NP)/2] × 100 = [15(1-0.4) + (189.84-94)/6] / [(189.84+94)/2] × 100 = [9 + 15.97] / 141.92 × 100 = 17.59% (ii) Calculation of Cost of Preference Shares: Net Proceeds = 100 (1.1) - 5% of 100 (1.1) = 110 - 5.50 = 104.50 Redemption Value = 100 Year Cash Flows (₹) PVF @3% PV (₹) PVF @5% PV (₹) 0 (104.50) 1 (104.50) 1 (104.50) 1-10 5 8.530 42.65 7.722 38.61 10 100 0.744 74.40 0.614 61.40 12.55 (4.49) K p = 3% + [(5% - 3%) / (12.55 - (-4.49))] × 12.55 = 3% + [2% / 17.04] × 12.55 K p = 4.4730%

Topics: Part-A: Financial Management

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