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In questions Close Co and NN Co the after tax cost of debt is worked out for redeemable bonds. However Close Co calculated it as 7x(1-0.3)=4.9% per year, whereas NN Co calculated it with linear interpolation. I’m so confused as to why?
Why the difference in method for both questions when the long term borrowing is the same source of capital?
Please tell me which exams they are in.
(Sorry but I can’t remember the name of every question in every exam 🙂 )
Apologies. Close co is in Dec 2011 and NN Co is in Dec 2010.
Normally, for redeemable debt we need to calculate the IRR (as in NN).
In Close we are told the pre-tax cost of debt and so we have to use that to calculate the market value. The after tax cost of debt will be the IRR (as in NN), but because the redemption is at nominal value, it will be equal to the pre-tax cost of debt multiplied by 1-t.
(Try it yourself and you will see that I am right 🙂 )