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Hi John, first of all thank you for your great lectures! I have a question which I was hoping you might be able to help with?
The question relates to the interest debenture cost for a company – I was wondering why in example 9 of the Chapter 6 the cost to the company is calculated based on the market value (8/92*70%*100%) of the debt, however in example 10 the cost is seemingly calculated on the nominal value of the debt (100*10%*70%)? I would think that if you look at the (current) cost to the company you would base this on the nominal value of the debentures issued and any future cost on the market value … or am I perhaps seeing this incorrectly?
In both cases, the actual interest payable each year is based on the nominal value (which is always assume to be $100 unless told differently). So in example 9 the interest each year is $8 less tax), and in example 10 is $10 (less tax).
When calculating the cost to the company, then when the debt is irredeemable (as in example 9, then the cost to the company is the after tax interest as a % of the market value. When the debt is redeemable (as in example 10) then we need to calculate the IRR.
(I do explain this when working through examples 7 and 8)
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