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Greetings Tutor, I hope you are doing well, can you please help me with a small question related to CORFE Co. (March/June 2019).
Req A) Calculator the after tax WACC of CORFE Co. on market value basis..
However there is no specific interest rate for Bank Loan, because as mentioned it has a variable interest rate.The suggested answer has taken post tax Cost of debt (7.44%) for 8% Loan Notes even for the bank loan. Which was also something that i was thinking to use.
But the fact that Cost of Equity has been calculated using CAPM, which has an important assumption of “Unrestricted Borrowing or Pending at Risk-free rate of interest.
Which states that CAPM assumes that all the investors can borrow and lend at the risk free rate of return, therefore provides minimum level of return required by all investors.So by giving reference to the above mentioned assumption under a Note,
can we use 3.5% (Riks Free Rate) tax adjusted as a proxy for Interest Rate for the Bank Loan?The 8% loan notes of Corfe Co have a nominal value of $100 per loan note and a market price
of $103.50 per loan note. Annual interest has just been paid and the loan notes are
redeemable in five years’ time at a 10% premium to nominal value
So It is redeemable debt so has to be calculated by IRR
So that is why the 7.44% is usedIt tells you quite clearly that the bank loan has a variable interest rate.
So you can use either int(1-t) of 6.4% or the IRR figure can also be used for the cost of debt of the bank loan.And it tells you that the risk?free rate of return is 3.5% per year and the equity risk premium is 6.8% per year. Corfe Co has an equity beta of 1.25
This indicates using CAPM
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