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- April 26, 2015 at 6:30 am #242749
sir
I have already went through the revision not. the following questions I do not understand when I looked at
1. in what situations can we use the risk free rate to calculate the cost of debt? in the revision note, some of the places used the risk free rate tot get the cost of debt directly.
2.Example, this is question is attached in the revision note
Company is financed as follows:
Equity: 10M $0.50 shares, quoted at $1.20.
Debt: $6M 9% irredeemable debenture (unquoted)
The ? of a share in the company is 0.85
The market return is 20%, risk free rate is 12%
Corporation Tax is 30%; Ignore Income Tax.
Calculate:
(a) the market value of debentures
(b) the WACC of the company
in the answers I do not understand ‘(No ? given for debenture, so assume risk free therefore investor require 12%)
M.V. Debt = 9/12% = $75 p.c.’ what does it mean? also when calculate the cost of debt, use 12%*(1-30%)? what situations can I use this method to get the KDat?
thanks!April 26, 2015 at 8:53 am #242769Why are you not watching the free lectures? I can’t type out all the lectures here 🙂
If you are not given enough information to calculate the cost of debt then we have no choice but to assume it is risk free. However, the risk free rate will not be the cost of debt because the company gets tax relief and so the cost of debt will be lower.
$75 pc means that the market value is $75 for $100 nominal.
If debt is irredeemable then the cost of debt is Kd(1-t) to account for the tax relief. If debt is irredeemable then it is necessary to calculate the IRR of the after tax flows. If not told, then we assume debt is irredeemable.
April 26, 2015 at 10:16 am #242776Ok. Thanks. May be I was missing some point during the lectures.
April 26, 2015 at 2:53 pm #242804You are welcome 🙂
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