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Hello sir I am stuck at one question below pls help me.
A company has an issue 200000 7 percent redembable bond at premium of 5 percent on 31/12/2016, int paid annually on bond. Current bond trading at £98 ex int per £100 nominal value and tax rate is 33 percent. We need to calculate cost of debt and IRRThe answer is as below
Time Cash flow PV @ 10. PV @ 5
0. 98
1-4 7*(1-0.33)
4. 105I don’t get how they assume to take present value at 10 and 5 for IRR.
Please help
The cost of redeemable debt is always the IRR of the after-tax flows.
Whenever we calculate an IRR (whether the IRR of a project or the IRR of redeemable debt), we always have to make two guesses.
What guesses you make doesn’t matter (unless obviously the question specifies which two to use).
Because the relationship is not linear, the answer is always only an approximation, and different guesses will give a slightly different answer. However this is irrelevant for the exam and still gets full marks.
Although it does highlight the importance of showing your workings neatly for Section C questions. The marks are for the workings rather than for the final answer, but you only get the marks if the marker can follow your workings.I do suggest that you watch my free lectures on this, because IRR is always examined in the exam – it is fundamental.
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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