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11 Answers

Infrastructure Bonds – To Buy or NOT (A Study)

Asked by: 604 views
Current News, Financial Planning, Income Tax

If you buy IDFC Bonds, for every 5000 invested you will be paid 11840 amount at the end of 10 years at 9% ROI.
As you know, the maturity amount is taxable. Hence, the net amount you would be getting would be 10620.48 OR 9400.96 OR 8181.44 depending on whether you fall under 10% OR 20% OR 30% bracket (with 3% educational Cess) respectively at the time of maturity.
Assume you have NOT invested 5000 this year, then you will have 4485 (@10%) OR 3970 (@20%) OR 3455 (@30%) in hand to invest after deducting tax + 3% cess.
Assume that you buy IDFC stocks @ 110 price. Then You would have 40 OR 36 OR 31 IDFC shares depending on the amount in hand as described above.
So if you are in 10% slab at the time of maturity, IDFC need to shoot up at the following rate to recover 10620:
You invest 4485 (@ 10%)-> get 40 shares -> For 10620, share value should be 265.5
You invest 3970 (@ 20%)-> get 36 shares -> For 10620, share value should be 295
You invest 3455 (@ 30%)-> get 31 shares -> For 10620, share value should be 342.58
So if you are in 20% slab at the time of maturity, IDFC need to shoot up at the following rate to recover 9400.96:
You invest 4485 (@ 10%)-> get 40 shares -> For 9400.96, share value should be 235.02
You invest 3970 (@ 20%)-> get 36 shares -> For 9400.96, share value should be 261.14
You invest 3455 (@ 30%)-> get 31 shares -> For 9400.96, share value should be 303.25
So if you are in 30% slab at the time of maturity, IDFC need to shoot up at the following rate to recover 8181.44:
You invest 4485 (@ 10%)-> get 40 shares -> For 8181.44, share value should be 204.53
You invest 3970 (@ 20%)-> get 36 shares -> For 8181.44, share value should be 227.26
You invest 3455 (@ 30%)-> get 31 shares -> For 8181.44, share value should be 263.91
Kindly let me know if my calculations are correct.
Assuming my calculations are correct, it does not make sense to invest in bonds if you are currently in 10% and 20% slab regardless of whatever slab you will be in at the time of maturity. This is because shares are likely to easily beat the above values within a span of 10 years.
However, if you are in 30 % slab it somewhat makes sense to invest in Bonds that too only if you are likely to be in lower tax slab after 10 years.
Please let me know your views and feedback.

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11 Answers



  1. justgrowmymoney on Dec 02, 2011

    Tejaswi – Very good analysis, that was one piece of a calculation, good one. I have attached an excel spreadsheet where I worked the numbers out. There are some minor differences in our numbers – let me know if you find something not right in my calculations.

    Having said that: (As I am typing this I just got an SMS: Save upto 6180 i taxes and earn 9% p.a. by investing in IDFC LT Infra bonds, LOL).

    1) Companies offer interest rates in the hope they can make more than that amount by investing in the business. Hence the total value of the company (not necessarily the share price) will grow by more than the interest rate being paid, at least,according to their business plans.

    2) IDFC is growing revenues at about 30+% per year and net income is growing at 27-30% every year. The market is ready to pay a PE of 11, comparable with its peer of infra companies, for this rate of growth. Hence if this growth falls due to some bad decisions by the company the price wont keep up with the earnings; PE will fall. So the price rise is never guaranteed.

    3) Bonds, more than for earnings, should be taken up for portfolio diversification. Just for this reason alone it will be advisable in everyone’s portfolio. You need to compare 9% return + tax saving of this bond versus a 10% FD for 10 years. [Tax saving FDs will fall under 80C anyways, the 80CCF LT bonds are beyond that 100,000]
    [file]http://www.jagoinvestor.com/forum/readers-files/IDFCBondvsStockCalculations.xlsx[/file]

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  2. ashal jauhari on Dec 02, 2011

    Dear Tejaswi, The very start of your calculation is wrong. For the maturity amount of 11840 Rs. only the income part i.e. 11840-5000 (basic investment) ‘ll be taxed. Hence After 10Y, the tax as per the then slab rate ‘ll be charged on 6840 Rs.

    Hence Post Tax interest amount ‘ll be like this –

    @ 10.3% slab = 6135.5
    @ 20.6% = 5431
    @ 30.9% = 4726.5

    Please read my other post also for Infra bonds. Without comparing with IDFC shares or any other thing. The 10% 20% tax slab people should avoid investing in Infra bonds.

    Thanks

    Ashal

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    • KK Babu on Jan 04, 2012

      Dear Mr Ashal ji

      Can I invest in IDFC in the name of my spouse and still get the IT Benefit for me?

      Will you suggest any good infra bond for saving IT (I hope this saving will be over and above 1 Lakh ceiling of 80C).

      Thanks, KK Babu

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  3. Tejaswi on Dec 02, 2011

    justgrowmymoney -
    Thank you for sending the calculation. I too did the same but made mistake of making the entire maturity amount as taxable. Ashal rightly pointed this out. Apart from that my calculation matches with yours.

    Thanks Ashal for pointing the mistake.

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  4. Tejaswi on Dec 02, 2011

    I also similar calculations on whether to prepay a home loan. Based on the calculations, I found that one should never prepay a loan if one is in 30 % tax slab. One should always consider paying the loan if one is in 10% slab.

    However, things get tricky if one is in 20% slab. Here, one should consider the CAGR of the invesment instrument . If you invest in PPF then it is not worth. However, one can continue with home loan only if he considers in an instrument that gives returns of atleast 10%.

    kindly let me know if anyone has did some sort of analysis in this regard and have concluded with similar inference.

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  5. ashal jauhari on Dec 02, 2011

    Dear Tejaswi, From your own calculations as the effective saving of tax is more for 30% tax slab, the person should not prepay but your remedy for 10% slab person is totally against this very logic of your’s. Why? Over the years the 10% slab person ‘ll rise to 20% & then to 30% now it’s the initial years where the interest burden is highest & if S/he opts to repay early for later years in 20 & 30% tax slab, the effective tax saving ‘ll be even less.

    House is the biggest investment of all of us, in fact life time investment & we the Indians are not comfortable with the idea of banks or Financial Institutions having their right on our home. Plus add the base of corruption, black money in real estate sector, the borrower ‘ll always try to close the loan as early as possible no matter what the financial calculations tell. This is more a sentimental decision than a pure financial one.

    Thanks

    Ashal

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  6. justgrowmymoney on Dec 02, 2011

    I agree on the point of sentimental decision but I also personally dont prefer prepaying home loan. The reason is little different. If my EMI is 20,000 for 20 years for a 20 Lacs loan I will eventually pay 48 Lacs in 20 years. This puts off a lot of people. If I prepay in 5 years in 2016 I may end up paying ~ 28 lacs by then but then inflation adjusted amount for 2011 will be some 24 lacs. Over a period of 20 years at such high inflation rates, although I will pay 48 lacs it will only be ~ 26-28 lacs in 2011 terms, That is the crux. Since I decide not to prepay and will invest in other money generating avenues my eventual cost of the home loan (+ tax savings) will make me finish way ahead.

    Net-Net if there is an investment where the return after tax is greater than the home loan rate then it makes less sense to pay off the home loan.

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  7. Tejaswi on Dec 03, 2011

    Suppose a person moves from 10% to higher slab then as a rule of thumb one should not consider part paying the home loan.

    Say I am 10% slab and have 10 lakh loan. If I have 2 lakhs in hand then I should pay the home loan. 1 year down the line if I happen to move to 30% slab and have got surplus 2 lakhs in hand then I should not be paying the loan rather invest it.

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  8. manickkam on Dec 03, 2011

    The stock market investment in IDFC and IDFC infrastructure bonds cannot be compared as such like this explicitly according to me.

    Investing through infrastructure bonds let me another avenue for saving tax and it should be at that point.

    IDFC stock investment can be compared to many other stocks to beat the index and if the person is comfortable fundamentally/technically (or whichever view he takes) on a particular stock, then he can carry on with that stock. There are so many people who want only safe returns!

    Also, there are many people in 10% and 20% slabs who want to increase their take home pay and have various side business, which make their family’s income in the bracket of 30%. So, they can afford to save tax this way.

    Its a safe debt instrument (comparably, given that its AAA rated by few rating agencies), it can be compared to other debt instruments available and we can come to a conclusion.

    If the tax treatment is there for the returns from the bond, it is a cause of concern. This can be compared with the Tax Saver FD and it is same as this, I guess.

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  9. ashal jauhari on Jan 04, 2012

    Dear KK Babu, To avail Tax benefit under section 80CCF for Infra bonds, investing under yor own name is a precondition. Hence if you opt to invest under your wife’s name, sorry dear no tax benefit.

    As on date IFCI Infra bonds are available for investment. The investment of 20K Rs. is available under section 80CCF over the basic limit of 1L Rs. under section 80C. Hence the total limit ‘ll be 1L + 20K = 1.2L Rs. for you if you are opting to invest in these infra bonds.

    Thanks

    Ashal

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