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Dear John,
Please explain why use 9% PV and annuity when question is conversion after 7 years?
Many thanks
The market value of debt is always the present value of the future expected receipts discounted at the investors’ required rate of return.
The future expected receipts are interest each year for 7 years (an annuity) and then the value after 7 shares.
The investors’ required rate of return is the same as the pre-tax cost of debt. The scenario says that the cost of debt is 9% (and there is no mention of tax) and therefore we discount the receipts at 9%.
(All of this is explained in my free lectures on the valuation of securities!)
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