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In this question there is:
8% Bonds ($100 nominal) = $120m
Before tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal value in six years’ time
How to calculate the market value of the bonds in easy way
I cant understand the examiners solution to thisThere is only one way to calculate the market value of redeemable debt.
The market value is the present value of the future expected receipts discounted at the investors required rate of the return.
Here the expected receipts from one bond (of 100 nominal) are the interest of 8 per year for 6 years, and the repayment of 100 in 8 years time.
The investors required return is 7% (the pre-tax cost of debt).The examiner has used the annuity factors to calculate the present value of the interest receipts, and added this to the present value of the repayment. This gives the value of one bond of $100.
Since the total market value of all the bonds in issue is $120M, he has then calculated the market value of all of them (using the value of each $100 nominal already calculated).
If you have not already seen it, I have a lecture on the valuation of securities where all this is explained.
Dear tutor,
I was thinking that the interest of 8% has to reflect the tax, ie, instead of 8 % p.a. we would have 8*0.7 = 5.6 that is paid over 6 years ( multiplied with the annuity factor).
Seems like I am misunderstanding an important point here. Please help me.
Thanks a lot!
You really should watch the lectures!!!
It is investors who determine the market value, and company tax is of no relevant to them.
They receive the full interest, and you discount at their full required rate of return.
(Tax is only relevant when calculating the cost of debt to the company)
This is an important point and is ofter asked – I do suggest that you watch the lectures on the valuation of securities.
Thanks tutor,
I have watched both lectures part a and b. Have you somewhere discussed the required rate of return further?
BR,
The required rate of return is discussed in lots of lectures.
Sometime we know the market value and are then required to calculate what the required return by investors must be; other times we are given the required return and are then required to calculate the market value; other times (with regard to shares) we have to use CAPM to calculate the required return and then use that to calculate the market value.
Everything is covered in the lectures – they are a complete course and are supposed to be watched in order.
However with the regard to the original question you asked, it is always investors who determine the market value of both shares and of debt, and company tax is never of any relevance to them.
Thank you so much for the responses.
Can we find somewhere a mock exam for this session? May be some guess what type of questions may come in this exam session?
Best regards,
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