Cost of Debt = IRR

One thing I will want you to understand is the concept of Internal Rate of Return (IRR). This concept make some assumptions. IRR can also be used as a breakeven point for a project. The fact is that IRR makes assumption that the return on the investment will be reinvested at the company’s cost of capital.

Relate this assumption to the cost of redeemable debt you will agree with me that interest earned if not paid will be compounding. That is will be added to the principal and form basis of further interest charge which mean reinvestment assumption associated with IRR. Also, the redemption value will be repaid at the terminal end of the debt which is also a cash flow item and interest is tax deductible. Note also that Market Value of the debt will play a significant role in determining the cost of debt.

Given these three different cash flows (Market Value, Interest and Redemption Value) associated with the redeemable debt the only way to establish the cost of redeemable/convertible debt is to extrapolate using IRR.

I believe with this little explanation you will now be comfortable with the Cost of Redeemable Debt.

Thanks and best regards.

Mohammed T. Elomi

Greetings

On internal rate of return, I have been using the 7-column analysis for computation of the IRR for redeemable debts. But one thing i would appreciate to get clarifications is what guides on determining the discount rates to use? I have been using the 5% and 10% for most of the cases, but i am not so sure why should i use them as these are not mentioned in the question, apparently in some other text books various rates such as 5% and 7% or 10% and 12% have been employed.

Thanks