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Qs 229 bpp kit
A company has in issue loan notes with a nominal value of $100 each.interest on the loan note is 6% payable at the end of year.the loan will be redeemable in 8 years at 5% premium. The before tax cost of debt is 7% while after tax is 5%.Dear sir
My question is that they are using before tax cost of debt while we have been taught to use after tax value. Can you please explaim why is that. ( and yes i have looked through all business valuation lectures and dont remember this sort of thing happening)I do not believe that you have been taught that, and my business valuation lectures have nothing to do with this!
There is absolutely no point in watching my lectures unless you watch them all, in the order in which they are presented – they are a complete course and cover everything (including this point) needed to be able to pass the exam well.
If you do watch all the lectures then you will find that it is investors who determine the market value of debt. Investors are not affected by company tax and therefore they determine the market value as the present value of future receipts (pre-tax) at their required rate of return. Their required return is pre-tax – tax only effects the cost to the company.
Please do not expect me to type out my lectures here if you are not bothering to watch them 🙂
Well i have watched all the lectures :/
I am just getting confused as to where we deduct the tax and where we don’t. I guess wacc is confusing me. The (i-t) in cost of debt calculation is confusing.
Anyway. Thankyou! 🙂But I explain this in my lectures as well! The (1-t) in the WACC formula only applies when the debt is irredeemable. Kd is the return to investors and (if the debt is irredeemable) then we multiply by (1-t) to account for the tax relief that the company gets, which makes the cost to the company lower.
If the debt is redeemable then the formula does not apply – we need to calculate the cost of debt by calculating the IRR of the after-tax flows.
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