# Kd – IRR

This topic contains 9 replies, has 3 voices, and was last updated by  John Moffat 1 year ago. This post has been viewed 49 times

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• #55658

dazhong0703
Participant

Eg
T0 purchase price (125)
T1-10 interest after tax 15(1-.25)
T10 redemption value 100

Usually we need to try DF5%, and DF10%, to determine IRR
But I see some suggested solution is: [15(1-.25)+(100-125)/10]/[(100+125)/2] = 7.8%

I think the logic is: (interest gain + principal gain)/(average of principal)

Can I use this method to get IRR straight away in the exam, pls? It is obviously much faster. Thank you.

#108468

nandinigirish
Participant

#108469

John Moffat
Keymaster

That method would give an approximation and you would be given some credit, but the correct way is to calculate the IRR properly (which only takes a minute if you are fast with your calculator!)

#108470

dazhong0703
Participant

If using Kd = Rf + (Rm-Rf) x Bd, there is no need to multiply (1-t) for Kd, isn’t it? Thanks.

#108471

John Moffat
Keymaster

That is correct

#108472

dazhong0703
Participant

Again I have seen two views, today I did a question: Kd(post tax) = (Rf + spread) x 0.7
[Tax rate = 0.3]

#108474

John Moffat
Keymaster

What do you mean ‘Again, I have seen two views’!?

If you think about it, Kd post tax is obviously 70% of Kd pre-tax – I don’t exactly see that there are two views.

Anyway, Kd is the return to investors and is always pre-tax. We are only interested in post-tax if we are looking at the cost to the company.

#108475

dazhong0703
Participant

Because the day before yesterday, I saw a question when calculating WACC, the ans straight away uses Kd = Rd + (Rm-Rf) x Bd, never multiply (1-t);
Then yesterday I saw another question the ans given for Kd(post tax) is as above.
I see from GTG revision card, Kd = (Rd + spread)(1-t), so I think it was my former lecturer’s mistake by not multiplying (1-t).

#108476

dazhong0703
Participant

Since debt has a credit spread, why did MM assume debt risk free? When degear/regear, we also assume debt risk free? The cause of debt crisis is interest too high!
Thank you.

#108477

John Moffat
Keymaster

Your GTG revision card is wrong if it says that.
Kd is the return to investors. It is the cost to the company that is Kd (1-t).
(Try looking at the formula for WACC on the formula sheet!!!!)

M&M ignored the risk of bankruptcy. If there is no risk of bankruptcy then the income is fixed and is therefore risk free. (That is one of the reason that M&M does not work perfectly in real life – in real life the risk of bankruptcy does exist.)

The formula for calculating the asset beta is really a M&M formula and that is why we assume for that formula that debt is risk free.

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