sir, in the last question the growth rate is 5.7% but I rounded it to 6 and got the wrong answer so that means we cannot round the growth rate figure right?

Could you please help me calculate ‘g’ the growth rate in questions 1 and 5.
I understand the answers working but cannot get the answer on my calculator!
Question 1: I am dividing 36 by 31.1 and then doing to the power of 3
Question 5: I am dividing 0.5 by 0.4 and then doing to the power of 4

I assume that you have watched my free lectures on the valuation of securities, in which case you are happy that the market value is the present value of the expected receipts discounted at the investors required rate of return.

On $100 nominal, the interest is $6 per year for 8 years. In addition there is the redemption in 8 years time at $105
These flows are discounted at the investors required return of 7% (the before tax return, because investors are not affected by company tax).

If you have not watched the lectures then I do suggest that you do.

Matthew has 8% convertible loan notes redeemable in 5 years at nominal of $100. Each note can be converted for 70 shares (nominal $1), currently at $1.25ps but growing at 4% pa.
Before tax cost of Matthew’s debt is 10% and after tax is 7%.

Dear Sir,
I cannot understand the difference between the before-tax cost of debt and the after-tax cost of debt, and when do we use each of them.

Have you watched the free lectures, because it is all explained in the lectures (and there is obviously no point in attempting the tests without having watched the lectures first)?

The market value is determined by investors and is the present value of their expected receipts discounted at their required return. Their required return is the pre-tax cost of debt, because the investors do not get the benefit of tax relief.

The after-tax cost of debt is the cost to the company and is lower because the company does get the benefit of tax relief on the interest.

i was about to ask you a question in the tutor forum regarding this as i have seen in wacc questions we find an IRR to find the cost of convertible debt and in the present value calculation (using two different rates), the interest is post tax but in an mcq: market value of convertible is to be calculated and in the present value calculation the interest has no tax effect. sir i guess your above comment justifies it. 🙂 thanks as always. May God bless you with the best sir.

we have to find the market value we have used before tax rate which is 10% but what if the question says that company pays tax 30% then which value we should use ?

Why have you not read the previous replies (and why have you not watched my free lectures) ?

It is the investors who fix the market value and company tax is of no relevance to them. The market value is based on the pre-tax interest and on the pre-tax rate (which is the investors required rate of return).

Matthew has 8% convertible loan notes redeemable in 5 years at nominal of $100. Each note can be converted for 70 shares (nominal $1), currently at $1.25ps but growing at 4% pa.
Before tax cost of Matthew’s debt is 10% and after tax is 7%.

My working – using 10% factors:
$8.00 * 3.791 = $30.33
$100 * 0.621 = 62.10
Value of note = $92.43
Answer is showing as $96

The redemption is not at $100. They are convertibles and they will be expecting to convert because the value of the shares they will receive is expected to be higher at $106.46.

(Are you not getting a pop-up window showing the workings after you submit your answer? If not then maybe you have a pop-up blocker installed and you need to disable it while doing the tests.)

The market value is the present value of interest of $7 per year for 7 years, and a a repayment of $105 in 7 years time, discounted at their required return of 9%.

Market value = (7 x 5.033) + (105 x 0.547) = $92.67

please boss, how do i get to watch the free lectures, i know its rather late to asking that, but i have a particular topic i want to get a feel of. id be really happy if i get a quick response

Libin Jacob ACCA says

sir, in the last question the growth rate is 5.7% but I rounded it to 6 and got the wrong answer so that means we cannot round the growth rate figure right?

John Moffat says

In sections A and B it is best not to round. In Section C, rounding is less important because it is your workings that get the marks.

Alan says

Hello John,

Could you please help me calculate ‘g’ the growth rate in questions 1 and 5.

I understand the answers working but cannot get the answer on my calculator!

Question 1: I am dividing 36 by 31.1 and then doing to the power of 3

Question 5: I am dividing 0.5 by 0.4 and then doing to the power of 4

John Moffat says

You need to take the third root in the first case, and the fourth root in the second case.

(For the fourth root you can take the square root twice. For the third root you do need a calculator that has an nth root button.)

Alan says

Thank you.

Your lecture in Chapter 17 on this helped (that and learning how to use my scientific calculator!)

John Moffat says

You are welcome 🙂

Cynthia says

i’m not getting the right answer for 3 question

could you please explain how its done?

John Moffat says

I assume that you have watched my free lectures on the valuation of securities, in which case you are happy that the market value is the present value of the expected receipts discounted at the investors required rate of return.

On $100 nominal, the interest is $6 per year for 8 years. In addition there is the redemption in 8 years time at $105

These flows are discounted at the investors required return of 7% (the before tax return, because investors are not affected by company tax).

If you have not watched the lectures then I do suggest that you do.

ruqayyah says

Question

Matthew has 8% convertible loan notes redeemable in 5 years at nominal of $100. Each note can be converted for 70 shares (nominal $1), currently at $1.25ps but growing at 4% pa.

Before tax cost of Matthew’s debt is 10% and after tax is 7%.

Dear Sir,

I cannot understand the difference between the before-tax cost of debt and the after-tax cost of debt, and when do we use each of them.

John Moffat says

Have you watched the free lectures, because it is all explained in the lectures (and there is obviously no point in attempting the tests without having watched the lectures first)?

The market value is determined by investors and is the present value of their expected receipts discounted at their required return. Their required return is the pre-tax cost of debt, because the investors do not get the benefit of tax relief.

The after-tax cost of debt is the cost to the company and is lower because the company does get the benefit of tax relief on the interest.

nadia says

i was about to ask you a question in the tutor forum regarding this as i have seen in wacc questions we find an IRR to find the cost of convertible debt and in the present value calculation (using two different rates), the interest is post tax but in an mcq: market value of convertible is to be calculated and in the present value calculation the interest has no tax effect. sir i guess your above comment justifies it. 🙂 thanks as always. May God bless you with the best sir.

John Moffat says

Thank you 🙂

haidershah says

even if company is paying tax ?

haidershah says

we have to find the market value we have used before tax rate which is 10% but what if the question says that company pays tax 30% then which value we should use ?

John Moffat says

Why have you not read the previous replies (and why have you not watched my free lectures) ?

It is the investors who fix the market value and company tax is of no relevance to them. The market value is based on the pre-tax interest and on the pre-tax rate (which is the investors required rate of return).

haidershah says

Thank You

John Moffat says

You are welcome 🙂

Vineeth says

Has the “Geometric average historical growth rate model” been explained in chapter 15? I did not find those in the lecture and notes.

John Moffat says

Yes it is explained. It is simply the way that past growth has been calculated in the lectures on the valuation of shares.

loong says

Question 5 of 5 (chapter 15 test 2 questions)

Using the dividend valuation model, my calculation was (0.5 x1.057)/(0.1-0.057) = $12.29

John Moffat says

But the growth rate is 5.74% (not 5.7%)

The correct workings appear as a pop-up window when you submit your answer.

Gary says

Matthew has 8% convertible loan notes redeemable in 5 years at nominal of $100. Each note can be converted for 70 shares (nominal $1), currently at $1.25ps but growing at 4% pa.

Before tax cost of Matthew’s debt is 10% and after tax is 7%.

My working – using 10% factors:

$8.00 * 3.791 = $30.33

$100 * 0.621 = 62.10

Value of note = $92.43

Answer is showing as $96

Have I gone wrong somewhere?

John Moffat says

The redemption is not at $100. They are convertibles and they will be expecting to convert because the value of the shares they will receive is expected to be higher at $106.46.

(Are you not getting a pop-up window showing the workings after you submit your answer? If not then maybe you have a pop-up blocker installed and you need to disable it while doing the tests.)

artid1 says

Hi

how do you calculate the answer to this question?

do i need to work out what the dividend was 4 years ago?

please help!

John Moffat says

Which question? There are 5 of them in this test!

(Have you watched our free lectures?)

artid1 says

Hi John,

it was question 4 of 5 (chapter 15 test 2 questions

I have watched the free lectures but I do not understand.

with the calculations it will make sense to me.

please can you guide me.

thank you

John Moffat says

The market value is the present value of interest of $7 per year for 7 years, and a a repayment of $105 in 7 years time, discounted at their required return of 9%.

Market value = (7 x 5.033) + (105 x 0.547) = $92.67

Oluwabusayo says

please boss, how do i get to watch the free lectures, i know its rather late to asking that, but i have a particular topic i want to get a feel of. id be really happy if i get a quick response

opentuition_team says

first you have to go to lectures page!

and if videos dont play – see support page for help

Gary says

Loan notes in issue of $100. Nominal int 6% payable annually. Redemption in Y8 at 100+5% = $105. Cost of debt 7%.

Using 7% factors:

My working is Y1-Y6 int at $6.00 * 5.971 = 35.83

and the redemption of $105 * .582 = 61.11

Total value of the note = 96.94.

Correct answer is 94.03?

Please help. Thank you so much.

John Moffat says

Sorry – the correct answer is 96.94

I will have it corrected. Thank you.