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Hi John,
In the below question WHICH discount rate would you use to calculate the present value of cash flows and WHY?
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%.
In future you must ask in the Ask the Tutor Forum if you want me to answer. This forum is for students to help each other.
When calculating the MV we always discount at the investors required return, which is the same as the before-tax cost of debt (i.e. 10% in this case). It is investors who determine the MV’s, and they are not affected by company tax.
You must watch my free lectures, because I explain and stress this in the lectures – it is very common in the exam.
Thank you Sir. I am going through the lectures now so will avoid such questions for sure.
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