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Sir,
I found this question on cost of redeemable debt. The answer is to calculate conversion value and discount it at 10% (loan note value = (3 x 3.791) (114.87 x 0.621) = $82.71) Can you please explain why interest is not taxed?
Thank you!
Lane Co has in issue 3% convertible loan notes which are redeemable in five years’ time at their nominal value of $100 per loan note. Alternatively, each loan note can be converted in five years’ time into 25 Lane Co ordinary shares.
The current share price of Lane Co is $3.60 per share and future share price growth is expected to be 5% per year.
The before-tax cost of debt of these loan notes is 10% and corporation tax is 30%.
What is the current market value of a Lane Co convertible loan note?
The question is not asking about the cost of debt – it asks for the market value.
It is investors who determine the market value, and they are not affected by company tax. The market value is the present value of their expected receipts discounted at their required rate of return. Their required rate of return is equal to the cost of debt before tax.
I do suggest that you watch my free lectures on the valuation of securities because I stress this point (and it is commonly asked in the exam).
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
OK, thank you!
When is actually tax relevant? When do I need to strip out the interest of tax?
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