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kindly help me with this,
we are given both market value and book value of debt and we’ve to find WACC,
if we use book value to find value of debt, is is necessary to use book value in calculating cost of debt aswel? or we can use market value in calculating cost of debt? i need a quick answer please..Cost of debt is based on book values, as the cost is derived from the interest paid on the nominal value of the debt. Interest is calculated based on the terms when issued, if the market value of the debt then changes, the cost to the issuer does not, else when people acquired debt notes etc.. they would increase the value to push up the return they received
the value of debt is market value, not nominal value. To calculate this you would use the IRR calc, with the market value offset by interest received and the final redemption value, usually par (ie value at issuance)
I would say that when calculating cost of debt (Kd) you need to use market value sometimes book value. eg.if its redeemed bond you need to use IRR and for small NPV calculation. For current period in your small NPV calculation you need to ask yourself how much would you pay for this bond if you bought it today. If you have given current ex int. market price you would use this price.Normally you should be given also redeemption value ,which will be different than current market price (example December 10,q.4)
But if you dont have given current ex int. market price of the bond you need to use book value and then as a redeemption value you will be told , like ex. June 11, q. 2).
BUT for WACC calculation you need to use always MARKET VALUES of the components of cost of capital. I mean you first calculate Ke, Kd, etc. and then you need to calculate market values of your shares, bonds etc, which give you the proportion and which then you will multiply by calculated Kd,Ke.Cost of debt is always calculated using market values.
The purpose is not to get the cost of the existing debt – that is irrelevant because the money has already been invested.
The purpose is to get the best estimate of the cost of raising more debt. The best estimate is got by looking at what return investors are demanding on existing debt currently when they buy the debt on the stock exchange.
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