A company requires ₦10,000,000 for a project. It can obtain the funds by either:

1. A bank loan of ₦10,000,000 at 12\% simple interest per annum, payable at the end of the year.

2. Issuing 10‑year debentures with a face value of ₦1,000 each (total face value ₦10,000,000). The debentures are issued at 96\% of face value and incur flotation costs equal to 2\% of the issue price. The coupon rate is 10\% per annum, payable annually.

Calculate the effective annual cost (as a percentage of net proceeds) for each option and state which source of finance is cheaper.

Question

A company requires ₦10,000,000 for a project. It can obtain the funds by either:

1. A bank loan of ₦10,000,000 at 12\% simple interest per annum, payable at the end of the year.

2. Issuing 10‑year debentures with a face value of ₦1,000 each (total face value ₦10,000,000). The debentures are issued at 96\% of face value and incur flotation costs equal to 2\% of the issue price. The coupon rate is 10\% per annum, payable annually.

Calculate the effective annual cost (as a percentage of net proceeds) for each option and state which source of finance is cheaper.

Accepted Answer

Debentures (effective cost ≈ 11.3 %)

Neco Model Questions Vol1 2019 Commerce Question 4

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