# The Cost of Capital Example 10

1. says

Sir, what exactly is redemption yield? Does gross redemption yield = Return to the investor( Which is IRR without considering tax) while net redemption yield = Cost of debt to the company.
Also, in eg 1 in Chapter 8, why have we not considered the initial outflow of \$100? Thanks for the help

• says

Yes – gross redemption yield is the return to the investor.
(Net redemption yield would be the cost of debt, but we don’t call it net redemption yield!)

With regard to question 1 in chapter 8, we are calculating the current MV of the bond, which is the PV of future expected receipts. (The \$100 is simply the nominal value).

(For this, it might help you to revise the F9 chapters on the valuation of securities)

Incidentally, I notice that in the lecture I refer to 2 questions in Section A. I must re-record it because that has of course changes and there is now just one question of 50 marks.

• says

I have done f9, but don’t seem to remember a few areas. Will go through them sir. Thanks 😀

2. says

Not a query. Just wanted to congratulate you, sir, for having been conferred with the Editors Special Award by PQ. Couldn’t be happier. You always teach everything in such a logical manner that it rids us of the need to blindly memorise formulae. Became a big FAN of yours ever since I watched the lecture on variance in f2 😀 Kudos!!

3. says

In relation to the IRR calculation –

Is it really a must that we guess percentages (in this case 10% and 5%) that will give us both a negative AND positive NPV? or can we also just as well calculate IRR after using percentages that give us NPVs that are BOTH positive?

• says

No – it is not a must. You can still approximate to the IRR (it is always an approximation anyway) if you have two positives or two negatives. But having a positive and a negative will give a better approximation.

That would not lose marks, provided they were not silly guesses. What I mean is that suppose you guessed at 5% and got an NPV that was enormously positive, then it would be a bit silly to make a second guess at only 6%. 10% or 15% would have been more sensible.

• says

There is no need to apologise – I can understand it must be harder if you have not taken F9.

I am not sure which NPV you mean.

However, I really do suggest that you watch the free F9 lectures (all except those on working capital, which is not examined at P4) – especially those on project appraisal, cost of capital, capital asset pricing model, and foreign exchange risk. So much of P4 is a repeat of F9 (and most of the extra topics do not make much sense unless you are happy with the ones from F9).

4. says

Hello Sir ,
I am a bit confused on the calculation of market values of debt and equity for WACC in example 10. market values are calculated on ex price or cum price of debt and equity ?

5. says

hi
am failing to listen to the lectures online, i have tried technical online help nothing is being done. pliz help

• says

I think it was a temporary problem – it should be working OK now.
(If not, then try a different browser e.g. Google Chrome)

6. says

Hi sir.This one is regarding MACAULAY DURATION . in bpp text it says when yield decreases duration increases but in an example i did(opentuition notes.ch8.Example4) lowering the yield has now effect on the duration.Why is that ?

7. says

Hi sir.
In Macaulay duration limitation you wrote that bond prices decreases as interest increases but using formula P0 = I / Kd
as we increases interest the market value increases?
Please help me with this how does interest increases decreases bond market price

Thank You

• says

It is investors who fix the market value of a bond from day to day, and it determined by the receipts that they are expecting and the rate of return that they require.

Here is a very simple example:
Suppose there are 5% bonds. On a \$100 dollar bond, the interest is fixed at \$5 per year. Suppose someone is thinking of buying a bond today on the stock exchange, but today they require return of 10% on their investment (maybe because banks are paying interest of 10%). Since the will only be getting \$5 a year, they will only be prepared to pay \$50 – because then the \$5 a year will be a 10% return.

The higher the required return, the lower the market value will be on the stock exchange.

8. says

Hi.
In the revised notes of chapter 8- the valuation of debt finance and macauley duration
Example 2 and 3, where did you get \$110 as redemption of the bonds??
I got \$110 as i assumes the nominal value being \$100 and i added 10% to it?

• says

The example says that the bonds are redeemable (repayable) at a premium of 10%.
It also says that the nominal value is \$100.

Any premium on redemption is always based on the nominal value.

So what you say is correct – but it is not an assumption that the nominal is \$100, because the question says that it is.

• says

I understand but in your answer there is \$118 as redemption value?? This is wht confuses me

• says

Sorry – I should have explained better.

110 is the repayment, and 8 is the interest for the final year.

• says

Oh.
I did 8 being the interest multiply by an annuity factor of 15%
And then did 110 multiply by a discount factor of 15 %.
Is that ok??

• says

Thank u:)

9. says

THAT MEANS I CANT REALLY RELY ON THESE LECTURES AS THEY ARE INCOMPLETE….
DIDNT EXPECT THAT FROM OT TEAM TO MAKE SUCH UNFORGIVEABLE MISTAKE…