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September 25, 2021 at 4:40 am
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%.
What is the current market value of a Lane Co convertible loan note? (Answer: $82·71)
Conversion value = $3·60 x 1·05(5) x 25 = $114·87
Discounting at 10%, loan note value = ($3 x 3·791) + ($114·87 x 0·621) = $82·71
Why the annual interest don’t need the after-tax value ? (3% x $100 x (1-30%) = $2.1)
Thank for help.
John Moffat says
September 25, 2021 at 10:45 am
In future please ask this sort of question in the Ask the Tutor Forum, and not as a comment on a lecture.
The after-tax interest is only relevant when calculating the cost of debt to the company.
When calculating the market value, we use the interest pre-tax because it is the investors who determine the market value and they are not affected by company tax. This is explained in the lectures on the valuation of securities.
December 6, 2020 at 4:01 am
Hi sir, in the calculation of cost of debt with redeemable debt, can I reverse all the signs? In other words, from the company’s perspective, market value will be a cash inflow since you imagine you issue new debt now and receive the cash while interest expense and redemption will be a cash outflow.
To me, this makes more sense and in the calculation of IRR, we will get the exact same answer but I’m more concerned about whether I will get marked down for this.
December 6, 2020 at 10:21 am
That is fine and you would not be marked down 🙂
October 27, 2020 at 11:28 pm
As it relates to redeemable debt, why didn’t we calculate tax on the 110 if it is not tax allowable?
October 28, 2020 at 7:59 am
I assume you are referring to the cost of debt calculation.
The interest is tax allowable to the company and so there is a tax saving. The redemption is not tax allowable and so there is no tax saving.
October 16, 2020 at 4:27 pm
HI john. Thanks for the amazing lecturer videos u provide, they make complicated stuff to easy peasy lemon squeezy.
in example 8 u find that investor’s required return (Kd) is equal to 11.86%. can we say that for every 100 unit of debt they require an interest of 11.86 without selling the note at discount.
also i want to know is there any relationship between the Kd and the market value of debt.
October 16, 2020 at 5:38 pm
No – the required return is the overall return that they are requiring. It is the overall required return that determines the market value of the debt.
October 16, 2020 at 7:13 pm
thank u very much john
March 2, 2020 at 4:00 pm
Hello, why do you take in Example 8 (b) the 85 as outflow in Year 0?
Wouldn’t the company pay out rather the Nominal than the MV?
March 2, 2020 at 5:08 pm
Nobody is paying out anything because the debt has already been issued.
As I explain in the lecture, we are looking at the existing debt to determine what return investors are currently requiring because if we issue new debt then we are going to have to offer the same return. We find out what return they are currently required by looking at the return on the existing debt borrowing.
April 17, 2019 at 2:14 pm
An item of plant with a carrying amount of $240 000 was sold at a loss of $90 000 during the year. Depreciation of $280 000 was charged (to cost of sales) for property, plant and equipment in the year ended 31 March 2018.
PTC uses the fair value model in IAS 40: Investment Property. There were no purchases or sales of investment property during the year
April 17, 2019 at 3:29 pm
This has nothing whatsoever to do with this lecture or to do with anything in Paper FM, and nor have you said what your problem is!
If you have a question then please ask it in the relevant Ask the Tutor Forum.
April 16, 2019 at 4:44 pm
can i do it like this below?
cost of capital
wouldn’t be much simpler and accurate?
i think i can do the same approach with investors return too
April 16, 2019 at 5:26 pm
For this question, if it is in Section A or B then you can do it that way.
However in a Section C question the examiner expects to you to calculate the IRR as I have done in the lecture (and in written parts of questions expected you to be able to state that it is the IRR).
April 16, 2019 at 5:54 pm
thank you john, really appreciate your effort and dedications. you lectures made acca look easier for me.
April 17, 2019 at 7:17 am
Thank you for your comment 🙂
August 16, 2020 at 5:19 pm
Can you explain the logic behind the calculation?
October 11, 2018 at 4:47 am
hello, coud you please clarify why you chose those two discount factors?
October 11, 2018 at 8:50 am
Have you watched the earlier lecture on calculating the IRR, because it is exactly the same ‘rule’.
You can use any two ‘guesses’. I tend to use 10% as my first guess because it is in the middle of the tables.
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