In Solution to Example 7, why are we diving the Cost of debt with the Current Market Price of 90. Dont we assume that the company always issued it at USD 100 at the time of raising the debt and the cost of capital will always be kd (1-t) for every year till it redeems it, Unless of course there is a redemption at a premium.

As I explain in the lecture, if it is quoted at 90 p.c. then it means the market value is $90 for every $100 nominal.
Therefore the interest each year (given a coupon rate of 8%) is $8 per year.
Therefore the return to investors (Kd) is 8/90 = 8.88%, and the cost to the company is Kd(1-T).

The price at which the debt was issued is completely irrelevant.

Here the debt will never be redeemed – the question specifically says that it is irredeemable.

If the debt is redeemable (which is more common in the exam) then the approach is different – we have to calculate the IRR and the cost of debt does not equal Kd(1-T), but this is dealt with in example 8.

I assume that you mean the 10% that I used as part of my calculation of the IRR to get the cost of debt.

When calculating the IRR you make two guesses. I chose 10% as one of the guesses but any two rates will do. Using different guesses does give slightly different answers (because the relationship is not linear) but still gets full marks in the exam.

I do suggest that you watch the earlier lectures on investment appraisal where the IRR calculation is explained in detail.

Venkatesh says

Hi John,

In Solution to Example 7, why are we diving the Cost of debt with the Current Market Price of 90. Dont we assume that the company always issued it at USD 100 at the time of raising the debt and the cost of capital will always be kd (1-t) for every year till it redeems it, Unless of course there is a redemption at a premium.

Can you kindly clarify.

Thanks

John Moffat says

As I explain in the lecture, if it is quoted at 90 p.c. then it means the market value is $90 for every $100 nominal.

Therefore the interest each year (given a coupon rate of 8%) is $8 per year.

Therefore the return to investors (Kd) is 8/90 = 8.88%, and the cost to the company is Kd(1-T).

The price at which the debt was issued is completely irrelevant.

Here the debt will never be redeemed – the question specifically says that it is irredeemable.

If the debt is redeemable (which is more common in the exam) then the approach is different – we have to calculate the IRR and the cost of debt does not equal Kd(1-T), but this is dealt with in example 8.

I do suggest that you watch the lecture again.

grisha says

Hello Mr.

Thank you for lectures

How did you get 10% ( you have discounted annuity and repayment at 10%) ?

John Moffat says

I assume that you mean the 10% that I used as part of my calculation of the IRR to get the cost of debt.

When calculating the IRR you make two guesses. I chose 10% as one of the guesses but any two rates will do. Using different guesses does give slightly different answers (because the relationship is not linear) but still gets full marks in the exam.

I do suggest that you watch the earlier lectures on investment appraisal where the IRR calculation is explained in detail.

grisha says

Thank You Mr. John

You are great teacher

John Moffat says

Thank you

Greenson says

Thank you sir this information is very useful..