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Market value of debt – Coeden (12/12)

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Market value of debt – Coeden (12/12)

  • This topic has 1 reply, 2 voices, and was last updated 7 years ago by John Moffat.
Viewing 2 posts - 1 through 2 (of 2 total)
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  • July 8, 2018 at 11:26 pm #461349
    duybachhpvn
    Member
    • Topics: 48
    • Replies: 34
    • ☆☆

    Hi John,

    In your second lecture on Cost of Capital, you mentioned that for redeemable debt, we must always use after tax cash flows to calculate the cost of debt to the company (the IRR of cash flows).

    Then come to Coeden question. In this question, we have a 5.2% redeemable debt where the risk free rate is 4% and credit spread is 90 basis points and tax is 20%. I have 2 questions on this
    1. The 4.9% cost of debt is the cost of debt to investor or the cost of debt to company? As you distinguished this clearly in the lecture, I guess it it cost of debt to investor and 4.9% * 0.8 is the cost of debt to company.

    2. In the answer when calculating the market value of this debt, they did not use after-tax cash flow but used the pre-tax cash flow and the discount rate at 4.9%. I am confused here now because you mentioned in the lecture that for redeemable debt, we must use after-tax cash flow to calculate the after-tax cost of debt to company and the cost of debt to investor * (1-T) does not work for redeemable debt. However in this question, the approach appears to be different that the pre-tax cash flow is used and the cost of debt to investor is used as discount rate instead.

    Thanks & Best regards,

    July 9, 2018 at 6:44 am #461361
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54721
    • ☆☆☆☆☆

    1. What you have written is correct.

    2. The after-tax flows are used to calculate the cost of debt. However the market value is determined by investors – they are not affected by company tax and therefore it is the pre-tax flows discounted at the pre-tax cost of debt.

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  • The topic ‘Market value of debt – Coeden (12/12)’ is closed to new replies.

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