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Hi,
I have a few questions regarding the answer to part (a) of the above question.
(i) Why have they taken 4.9% as the cost of debt instead of the coupon rate of 5.2%? I understand how to calculate the value of 4.9% but I’m confused about the difference between the coupon rate and this 4.9% value.
(ii) Why haven’t they taken the post-tax cost of debt by multiplying the cost of debt by 0.8?
I would really appreciate an answer to this.
Thank you1. The coupon rate is the interest paid on the nominal value.
We usually calculate the cost of debt by calculating the IRR of the after tax interest and redemption paid on the market value.Here, we do not know the market value but the question does tell is that the return to investors (which is pre-tax) is the risk free rate of 4% plus 90 basis points and so is 4.90%.
When calculating the market value of the debt, it is investors who determine the market value and so we discount the interest and redemption flows to the investors (which are pre-tax) at the return to investors which is 4.90%.
2. When calculating the WACC we use the post-tax cost of debt and the answer has multiplied 4.9% by 0.8 in the calculation of the WACC.
Thank you very much! That made it clearer.
And my mistake I did not see that they have incorporated the tax rate when calculating the WACC.
Really appreciate the prompt reply! Thanks again and stay safe 🙂
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