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Hi,
I’m looking at the BPP Study Text and I’m a bit confused with one of the examples:A company has outstanding $660,000 of 8% bonds on which the interest is payable annually on 31December. The debt is due for redemption at par on 1 January 20X6. The market price of the bonds at 28 December 20X2 was $95. Ignoring any question of personal taxation, what do you estimate to be the current cost of debt?
In the solution they omit interest paid on 31 Dec X2 as one of the cash inflows. The exercise is not saying that market price of $95 (from Dec 28) is cum int, and we were to assume that if it is not said, we should assume it’s ex int. Shouldn’t we then add interest for 31 Dec X2 as inflow with discount factor of 1?
Thanks!
Firstly (as I say in my free lectures) we always assume that market values are ex int (or ex div in the case of equity) unless told differently.
Secondly, we always use the ex int market value as the time 0 flow when calculating the cost of debt – we certainly do not add on the interest at time 0. (If we were given the cum int value, then we would subtract the interest at time 0 in order to get the ex int value).
I do suggest that you watch my free lectures on this. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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