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Henryted has 12% irredeemable bonds in issue with a nominal value of $100.The market price if $95 ex interest.Calculate the cost of capital if interest is paid half yearly?
Well i am ok with solving such questions but this half yearly thing is beyond me.
The answer is (1+6/25)^2 -1 =13%
why is the examiner taking a square and then subtracting it by 1?It is using the compound interest rule.
If r is the six monthly rate, and R is the yearly rate, then (1+R) = (1+r)^2 because there are 2 six month periods in a year.
I don’t think that the examiner has ever asked this in relation to the cost of debt. However the principle has been asked lots of times in other question – in particular when looking at the cost of giving discounts to receivables as you will see in my free lectures.
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