A Company issues 10,000, 10% debenture  of 10 naira each and realizes 95,000 naira  after allowing 5% commission to brokers. The debentures are redeemable after 10 years. Calculate the effective cost of debt before task.

To calculate the **effective cost of debt** before tax, we need to consider the following elements:

1. **Nominal value of the debentures issued**: 10,000 debentures of 10 naira each, so the total nominal value is:

   \[
   10,000 \times 10 = 100,000 \, \text{naira}
   \]

2. **Amount realized after issuing debentures**: 95,000 naira (after a 5% commission).

3. **Interest rate on the debentures**: 10%, which means the company pays interest of:

   \[
   10\% \times 100,000 = 10,000 \, \text{naira annually}
   \]

4. **Term of the debentures**: 10 years.

### Effective cost of debt (before tax)

The effective cost of debt (denoted as \( k_d \)) can be calculated using the formula for **Yield to Maturity (YTM)**. Since the debentures are redeemable, this is an approximation:

\[
k_d = \frac{\text{Annual interest payment} + \frac{\text{Redemption value} - \text{Net proceeds}}{\text{Number of years}}}{\frac{\text{Redemption value} + \text{Net proceeds}}{2}}
\]

Where:
- Annual interest payment = 10,000 naira
- Redemption value = 100,000 naira (the face value of the debentures)
- Net proceeds = 95,000 naira
- Number of years = 10

Now, let's compute \( k_d \):

\[
k_d = \frac{10,000 + \frac{100,000 - 95,000}{10}}{\frac{100,000 + 95,000}{2}}
\]

Let's break this down:

\[
k_d = \frac{10,000 + \frac{5,000}{10}}{\frac{195,000}{2}}
= \frac{10,000 + 500}{97,500}
= \frac{10,500}{97,500}
= 0.1077
\]

Thus, the effective cost of debt before tax is approximately **10.77%**.

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Would you like more details on this calculation, or have any questions?

Here are five related questions:
1. How does tax affect the cost of debt?
2. What is the difference between nominal and effective cost of debt?
3. Why is the broker's commission considered in this calculation?
4. How would the calculation change if the debentures had no redemption period?
5. What is the significance of yield to maturity (YTM) in financial analysis?

**Tip:** When issuing debt, remember that the effective cost includes not just interest payments but also any issuance-related costs, such as broker commissions.

A Company issues 10,000, 10% debenture of 10 naira each and realizes 95,000 naira after allowing 5% commission to brokers. The debentures are redeemable after 10 years. Calculate the effective cost of debt before tax.

Learn how to calculate the effective cost of debt before tax for a company issuing 10,000 debentures at 10% interest with a 5% broker commission. The debentures are redeemable after 10 years. This guide covers the Yield to Maturity (YTM) formula and effective cost of debt calculation. Ideal for college-level finance students.

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