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A 7% loan note will be repaid at its nominal value of $100 in one year’s time. The company which issued the loan note currently has a before-tax cost of debt of 8% and pays tax at 30%.
What is the current market value of the loan note (to the nearest $)?
The answer goes as this :
The correct answer is $99
The market value of a loan note equals the present value of its future cash flows discounted at the required return of the debt holders (i.e. the issuer’s pre-tax cost of debt):
$107/1.08 = $99Can you please explain why they took the above values for the answer , why and how they got 107 ?
I did the question as = Interest of 7/ cost of debt 0.008 which gave me 87.5
To calculate the present value, we divide the future cash flow by (1 + required return). In this case, it would be $100/1.08 = $92.59.
However, the question states that the loan note will be repaid at its nominal value of $100 in one year’s time.
Therefore, the market value of the loan note should be equal to its nominal value.To find the market value, we need to discount the nominal value by (1 + required return).
$100/(1 + 0.08) = $92.59 * (1 + 0.08) = $99 (rounded to the nearest $).
So, the current market value of the loan note is $99.
so whenever the question mentions that the loan note will be repaid at it’s nominal value, the MV should be calculated using the above method , am i right ?
A 5% $100 loan note will be repaid at its nominal value after one year. The before-tax cost of debt of the loan note is 4% and the corporate tax rate is 30%.
What is the current market value of the loan note (to the nearest $)?
This is a very similar question to the above , however they aren’t doing the same method for it and why is that ?
The given answer is :-
The market value of a loan note equals the present value of its future cash flows discounted at the before-tax cost of debt.
105 /1.04? = $100.96 i.e. $101 to the nearest $.
Well I can’t explain it then unfortunately
They must be written by two different writers
Report it to the ACCA study hubOh okay
In case we get a question like this in exam , pls let me know which method I’m supposed to followCan you please explain me this question too
A company currently has 1,000 ordinary shares in issue and no debt. It has the choice of raising an additional $100,000 by issuing long-term debt at a 9% annual interest rate, or issuing 500 ordinary shares. The company has a 40% tax rate.
What level of earnings before interest and taxes would result in the same earnings per share for the two financing options?
The answer is 27000.
WORKING
Equity Debt
EBIT 27,000 27,000
Interest expense 0 (9,000) (100,000 × 9%)
Profit before tax 27,000 18,000
Taxes (40%) (10,800) (7,200)
Net income 16,200 10,800
÷ Shares outstanding 1,500 1,000
EPS $10.80 $10.80Another strange question:
EPS= EBIT/No. of shares.
So, we equate the formula for the 2 options.
Assume EBIT is “x”.Option 1= Raising Debt.
Interest on debt should be considered as 9% on $100,000= $9000.
Applying the EPS formula, (x-9000)*0.6 (post-tax income)/1000 shares.Option 2= Raising equity. EPS= x*0.6/1500 shares.
Now, equate the two options and solve for x, then use this in either of the formulas to get EPS.
Now put $27,000 into either of the EPS formulas:
Opt 1 [.6 * ($27,000 – $9,000)] / 1,000 = $10.80
Opt 2 ($27,000 * .6) / 1,500 = $10.80
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