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.
Hi sorry, I could get same answer of your = 7.8%
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!)
If using Kd = Rf + (Rm-Rf) x Bd, there is no need to multiply (1-t) for Kd, isn’t it? Thanks.
That is correct
Again I have seen two views, today I did a question: Kd(post tax) = (Rf + spread) x 0.7
[Tax rate = 0.3]
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.
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).
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!
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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