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Hey John,
I had a doubt regarding the question GNT Co. from the pilot paper.
They have used something similar to IRR to calculate the Gross Redemption Yield, I haven’t seen this before and I don’t understand why we are doing this calculation or how the GRY is estimated from this approach. The rest of the sum is straightforward. Please help.
I assume that you are happy calculating the cost to the company of redeemable debt – it is the IRR of the interest and redemption(repayment) amount, but for the cost to the company we use the after-tax interest because the company gets tax relief on the interest.
(calculating the cost of debt was important in F9 and is equally important in P4).The redemption yield is exactly the same except that we are calculating the return to the investors. They receive the full interest, and so again we calculate the IRR but we use the gross interest in the calculation.
I hope that makes sense, but if not then watch the F9 free lectures on Cost of Debt where I go through an example calculating both the return to investors (the redemption yield) and the cost to the company.
It does make sense, I didn’t know we used an IRR approach for calculating the redemption yield. I think I missed that bit when I was studying, and just saw it in the Revision Kit.
Thank You John.
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Dear Sir,
Would it be the same if we calculated the effective interest rate of the bonds (gross redemption yield) using IRR and our own figures instead of approximation as ACCA?
Also, i assume they calculated 4% as the closest to the GRY, but the 0,2% i don’t understand how it was calculated.
Thanks
As always when calculating the IRR we can use any two ‘guesses’ (provided they are not ridiculous guesses). The answer will always only be approximate because the relationship is not linear.
I am not clear what you mean by your second question. The IRR comes to 4.21% and so the answer has used 4.2% for the rest of the answer. Even rounding to 4% would still have got probably all of the marks. (Although it does highlight the importance in P4 of making sure your workings are easy to follow – the marks are for the workings rather than for the final answer.)
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Dear Sir,
I’m still having some difficulty understanding this IRR style approach.
1. Would it be the ok if we did a pure IRR calculation and apart from the year 1-4 interest (excluding tax because ‘we’ are the investor) receipts and the repayment amount, we ALSO included the cost (current Market Value of the Bond) to purchase the Bond in year 0?
I have just watched your F9 cost of debt video
Yes – that is always how we set up the flows and how we calculate the IRR.
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Thank you very much!
PS: Would it be permissible on my behalf to inquire if you are also a P4 marker ?
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