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Hello sir,
When we want to calculate the post tax cost of debt for a redeemable bond we cannot just directly multiply (1-t) to the YTM to get the answer like we do for irredeemable bonds.
So, how come we do this, to find the post tax cost of debt when we are using the credit spread technique?
For example if a 5 year bond has an A rating and the equivalent treasury bond has a return of 3.6%:
We could sayYTM for the bond is 3.6% + 0.65%(using the table) = 4.25%
to get the post tax cost of debt we simply multiply this by 0.70 (assuming tax 30%) to get 2.975%.
I thought you could only do this for an irredeemable debt. To get the Kd(1-t) for a redeemable, dont we have to find the IRR using net of tax interest as the cash flow? Am i missing something? Can you please clarify this.
Strictly we should do as you say, but it will be quite time consuming because first we would have to calculate a market value using the YTM, and then calculate an IRR of the post-tax flows.
It is clear however from the examiners own answers to this sort of question that (unless obviously specifically told otherwise) he does not expect all the work (even though it would still get the marks) but accepts just this quick approach.
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