Section C Q – 56 Close Co. (Kaplan revision kit)

I do not have the Kaplan Revision Kit (only the BPP Revision Kit).

If it is a past exam question then please tell me which exam it was in, because I have all the past exam questions and so will then be able to look at it 🙂

(If it is not a past exam question, then is this a new bond being issued or a bond that already is in issue? If it is a new bond being issued, then it will be issued at par (unless specifically told otherwise), and therefore the market value will be the par (nominal) value.)

I have found it – it was in the December 2011 exam.

You are not given the market value of the 8% bonds, but you are told that the before-tax cost of debt is 7%. The market value of the bonds is the present value of the future receipts (interest each year for six years and then redemption in 6 years time) discounted at the investors required rate of return (which is the same as the before-tax cost of debt).
So you can calculate the market value yourself, and then calculate the after-tax cost of debt for use in the WACC calculation.

I do suggest that you watch my free lectures on the valuation of securities.
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.

Strictly, you do need to calculate the IRR because the debt is redeemable.
The cost is only Kd(1-t) if the debt is irredeemable.

However, as the examiners answer states, the answer is very close and so he accepted either way.

Again, I do explain this in my free lectures on the cost of capital.