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DDD Co has two loan notes in issue, each with a nominal value of $100 per loan note.
Loan note A will be redeemed at nominal value in 10 years’ time and pays annual interest of 9%. The current ex-interest market price of this loan note is $95.08.
Loan note B will be redeemed at a premium of 5% in four years’ time and pays annual interest of 8%. The pre-tax cost of debt of this loan note is 7%.
Which of the following is closest to the pre-tax cost of debt of loan note A?
A. 7%
B. 10%
C. 12%
D. 14%The correct answer is B.
Can you explain this question please .
the answer can only be found using the spreadsheet IRR formulae tho however this is a sec B question
The pre-tax cost of debt refers to the interest rate that the company must pay on the loan note before accounting for any tax benefits
We can determine that it is closest to 10% based on the fact that the current market price of the loan note is below its nominal value.
When the market price is below the nominal value, it indicates that the effective interest rate is higher than the coupon rate.
Therefore, the pre-tax cost of debt for loan note A is likely higher than the coupon rate of 9% and closest to the option B, which is 10%.Also
mv 95.08 = approx Int * annuity + Redemption * pv
= 9 * 6.145 + 100 * 0.386
94 so close to 95mv 95.08 = 9 * 7.024 + 100 * 0.508
it doesn’t come close
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