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I am practicing the Past exam CBE Dec16
Question 22: question of market value of 7% convertible loan note. The before-tax cost of debt of Coral Co is 5% and the company pays corporation tax of 20% per year. However, in the answer, the tax rate is not deducted from the interest paid. I suppose it should be deducted 7% x 100 x (1-0.2) = 5.6 then discounted 5%. Could you please explain this?
Q20 Upward-sloping yield curve
“The risk of borrowers defaulting on their loans increases with the duration of the lending”, and
“The government has increased short-term interest rates in order to combat rising inflation in the economy”
Both statements seems right for me. But only the first statement is correct as per provided answer. Could you please help to explain to me why the second statement is wrong.Thank you Sir in advance.
Q22. It is investors who determine the market value, and we therefore discount at their required rate of return which is the same as the before-tax cost of debt. Corporation tax is not relevant to the investors.
Please do watch my free lectures on this (because this is a very common question in the exam).
Q20. The yield curve related to long-term not short-term borrowing.
Please do watch my lectures – they are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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