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  1. avatar says

    Dear Sir, could you clarify this for me?
    When calculating the cost of debt (redeemable) we should always use the current ex int market value of the bond if given else we assume nominal value of $100 right?

    I have been working some past papers and i noticed this while checking the answers.
    For 12/10 question NNN Co the current ex int market price of $103.50 was used.
    For 6/11 AQR Co the nominal value was used, and for BKB Co (12/12) the calculated market value of bond $105 was used…

    • Profile photo of John Moffat says

      We always use the market value and it is always given in one way or another.

      In AQR the nominal value was used simply because if we issue at par then its immediate market value is the issue price – i.e. nominal.

      In BKB we were needed to calculate the market value first, but then the market value was used to calculate the cost of debt.

      It is always market value – there is no confusion.

  2. Profile photo of olakade says

    Please, I’m confused about the inflow and outflow in the cost of debt calculation. You put the MV as an outflow while the interest paid and the repayment value as inflow. While this please because if the current MV is inflow and the interest paid and the redemption paid are outflows, the result for IRR will be different. I hope you get what I mean. e.g df@5% will give a negative NPV of 19.42 and df@10% will give a positive NPV of 0.77. Then, IRR = 5.19% totally different from 9.81%. Please, explain which one is correct because I think 5.19% is logical looking from company’s view. Thanks.

    • Profile photo of John Moffat says

      It does not matter which way round the flows are. If the flows are reversed then the sign of the NPV will be the opposite. However, we are after a NPV of zero – minus zero and plus zero are the same!!

      I have no idea how you arrived at 5.19% – just looking at the figures should make you realise that 5.19% is impossible. Since the NPV at 10% is almost zero, the IRR must be very close to 10%!!

  3. avatar says

    Dear Professor John

    some thing I just want to confirm, can we write the abbreviation for terms which we use it often in the exam , i.e. in Example 9 ( $2.50 cum div & 92 ex int )

    by the way, does “cum div” mean included div, and “ex int” mean excluded interest ?

    sorry for asking such kind of simple question, but it’s really confused students who’s native language is not English like me… if we can use the abbreviation during the exam, could u show us some clue please ?

    Thanks for your brilliant lecture, I learned a lot here.

    • Profile photo of John Moffat says

      Yes – cum div means that they are about to pay the dividend (and so the price includes the dividend). Ex div means that they have just paid the dividend (and so the price excludes the dividend).

      The same applies to cum and ex int.

      In the exam you always assume ex div / ex int unless you are told differently.

  4. avatar says

    could someone please help me. I don’t understand the concept of “90 over 100 nominal”
    what does this mean? furthermore i don’t understand the logic between the investors borrowing from the Business, or is it the Business selling debt? if its the Business selling debt, are they selling the debt which is worth 100 i.e nominal for 90?

    • Profile photo of John Moffat says

      The market value is what investors are prepared to pay to buy debt on the stock exchange.

      To explain the relevance, suppose a company has in issue some 9% bonds with a nominal value of $100, which are trading at a market value of $90.
      This means that investors are currently requiring a return of 10% (9/90). If they wanted a different return they they would pay a different price.

      So…..this in turn means that if the company wanted to raise more debt finance, then they would have to offer a return of 10% (otherwise nobody would be prepared to invest)

  5. avatar says

    Hi John,

    I’m practising June 2009 past paper, titled ‘KFP Co’ using Kaplan exam kit.

    I’m calculating cost of debt and I’m bit confused with which discount factor to use. The question says its 7% redeemable bond in 7 years and under other relevant information it gives an average return on the market 10.5%.

    In the answer they have used 10% and 5%, but my understanding is that if it’s 7% interest then I would use 7% discount factor (which gave me positive NPV) and then I used 10% (giving me negative NPV). I get an IRR= 8.65% but the answer in kit gives an IRR = 6%, please can anyone look at this question and tell me where I’m going wrong.

    Thanks

  6. Profile photo of annchen says

    @johnmoffat
    Please allow me the following question: while i understand that we compute the investors return using the market rate, from the company’s perspective, in order to compute the cost, i would use the nominal, since this is the amount actually received. I don’t see where the market price of the debenture would influence the company’s cost. Therefore the net yield would be (1-tax (%)) x interest / nominal. Could you please advise?

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