Question 18.7: Assume everything to be the same as in Example 18.6, except ......

\,   (i) k_d, based on Equation 18.3,
\qquad \qquad k_d = k_i\, (1\, –\, t) \,(1 \,+\, r)\, (1 \,+ \,f) + r               (18.3)
provides the approximate value of the rupee.
\,       k_d = 11% (1 – 0.35) (1 + 0.02) (1 + 0.0015) + 2%
\,             = 7.16% + 2% = 9.16%
\,  (ii) Determination of kd, based on trial and error
k_d is given by the following equation (amount is in million $)
\,                $ 62.8874 = \frac{\$\> 4.5918}{(1+k_d)^1}+\frac{\$\> 4.6855}{(1+k_d)^2}+…+\frac{\$\> 76.3769}{(1+k_d)^6}

\,    By interpolation, k_d = 10% – \left\lgroup\frac{\mathrm{\$ \>62.8874 \,−\, \$\> 61.1351= \$\> 1.7523 \>million}}{\mathrm{\$ \>64.0576 \,−\, \$\> 61.1351= \$\> 2.9225 \>million}} \right\rgroup

\,                                 k_d = 10% – 0.6% = 9.4 per cent
The comparison of the effective cost of debt in Examples 18.6 and 18.7 is revealing in that the k_d is slightly less than double when exchange rate of the currency in which borrowings are made appreciates (k_d = 9.4 per cent); the corresponding value of kd is 5.1 per cent when exchange rate depreciates.
\, In brief, the finance manager should take into account all the major factors, namely, exchange rate, rate of interest, corporate taxes, flotation costs, mode and timing of payment of interest as well as principal, tax laws applicable to exchange losses/gains, treatment of flotation costs and so on in determining k_d. For the\> precise\> measurement\> of\> k_d\> the \>IRR based\> approach \>should \>be \>preferred.