1. avatar says

    Hello John,

    Was wondering if you could help me with this quick exam question, cannot understand the answer, please. A co has 7% loan notes in issue redeemable in 7 years at 5% premium to nominal value $100. Before tax cost of debt is 9% and after tax cost of debt is 6%. Current MV? Thank you very much in advance. Marina

    • Profile photo of John Moffat says

      In future please ask this sort of question in the Ask the Tutor Forum, and not as a comment on a lecture.

      The market value is the present value of the future receipts discounted at the investors required rate of return.
      On $100 nominal, the future receipts are interest of $7 per year for 7 years, and repayment of $105 in 7 years time.
      You discount these flows at 9% (the investors required return).

      Tax is not relevant because it is the investor who fixed the market value, and company tax does not affect them.

    • Profile photo of John Moffat says

      Don’t worry too much about it.

      It is just that some investments give low returns from year to year (in terms of the interest payment or (in the case of shares) in terms of dividends) but the market value grows.

      On the other hand there are other investments that give high returns from year to year, but the market value doesn’t grow (or might even fall).

      Overall, you would expect the total return (cash each year + capital growth) to be similar, but investors have the choice between investments giving high return and low capital growth or low returns but high capital growth.

      You don’t need to worry about numbers here at all.

  2. Profile photo of John Moffat says

    The redemption yield takes into account not just the interest each year but also the “gain or loss” on redemption (repayment) – i.e. the difference between the price to pay now (market value) and the amount repaid on redemption.

      • Profile photo of John Moffat says

        @atiq422, There is a capital loss, but this is not the redemption yield for two reasons.

        Firstly it is the ‘overall’ return including the interest that is receivable.
        Secondly it is the annualised return.

        Although you cannot be expected to calculate it, it is in fact just the IRR of the flows.

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