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7% bonds are redeemable at a 5% premium to their nominal value of $100 per bond and have an ex interest market
value of $104·50 per bond. The bank loan has a variable interest rate that has averaged 4% per year in recent years.
AMH Co pays profit tax at an annual rate of 30% per year.
Required:Cost of debt of bank loan
If the bank loan is assumed to be perpetual (irredeemable), the after-tax cost of debt of the bank loan will be its after-tax
interest rate, i.e. 4% x 0·7 = 2·8% per year.
sir I dont understand why the adbt is assumed to be perpetual(the question did say it.), again why apply the tax. used 4% as cost of debt loan.Bank loans are not repaid at a premium – they repay the same amount as they borrowed.
So the cost of the loan is always the interest rate x (1 – T), regardless of how long the loan is for. (It is not assuming that it is perpetual, whatever the answer might say).
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