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Hello , in chapter 15 , “4.8 example: cost of debt capital(4)” , the solution to part b in year 0 shows a cash flow of $8 , but shouldn’t this be ($95)?
Ok, I understand why its 8, its because they are trying to find the market value so that’s the interest . What I don’t understand now is why the 8 in shown in year 0 as opposed to year 1?
I do not have BPP books and so I cannot help you without seeing the example.
what i think is that since per the question bonds were issued on 28 th of december 20X2 and the interest is payable on 31 dec. every year ( as mentioned in the question ) , so they are counting 20X2 as well but this then contradicts with the solution of part a where they start counting interest payment from year 20X3 and not 20X2
I hope SIR you would have got an idea of what we are talking about here would be really glad if u can help us and take away our confusionIf the market value is cum int (i.e. interest about to be paid) then you need to include the interest about to be paid (i.e. at time 0).
If the market value is ex int (i.e. interest had just been paid) then you do not include the interest at time 0.We always assume that market values are ex int (unless specifically told otherwise, which is very unusual for the exam).
ya thats ok but Sir they havent mentioned anything so we assume its ex-
in part a we are asked to calculate cost of debt which comes out 10% and they do not take interest in 20X2.
in part b it says that if the new expectation emerged that cost of debt would rise to 12% during 20X3 and 20X4 what effect it would have on the market price at 28 dece 20X2?
so in part b they have taken interest in year 0The fact that the date is 28 December indicates that it is cum div.
I really cannot help more because I do not have the BPP book.
Have you watched my lectures on the valuation of securities and on the cost of capital?
(a) A company has outstanding $660,000 of 8% bonds on which the interest is payable annually on 31
December. The debt is due for redemption at par on 1 January 20X6. The market price of the bonds
at 28 December 20X2 was $95. Ignoring any question of personal taxation, what do you estimate
to be the current cost of debt?(b) If a new expectation emerged that the cost of debt would rise to 12% during 20X3 and 20X4 what
effect might this have in theory on the market price at 28 December 20X2?Because you are given the market value as at 28 December, the price will be cum int.
So…..the schedule (for $100 nominal) is:
0 (95)
0 8
1 to 4 8 p.a.Then calculate the internal rate of return to get the cost of debt.
(This is assuming that there is no company tax)(b) If the cost of debt increases, then the market value will fall (because the market value if the present value of future receipts).
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