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Hi,
I need a little nudge on how to read exam questions!
I’m looking at a section A question:
A company has 7% loan notes in issue which are redeemable in seven years’ time at a 5% premium to their nominal value of $100 per loan note. The before tax cost of debt of the company is 9% and the after-tax cost of debt of the company is 6%.
What is the current MV of each loan note?
I don’t need the calculation itself explainig to me, I just wanted to show you an example of wording I’m talking about. I calculated this using the 6% as the DF but looking at the answer it uses 9%. I’m a bit unsure with questions like this how to recognise when I should be using ater tax cost and when to use before tax cost. Can you tell me how I’d know?
Thanks 🙂
The MV of debt is always the present value of the future receipts discounted at the investors required rate of return – it is the investors who determine the market value.
The investors are not affected by company tax and therefore we always discount at the before tax cost of debt.
It is only when we are calculating the cost to the company that tax is relevant.
I do suggest that you watch my free lectures on this – I stress this point and it is something that is very commonly asked in the exam.
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