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John Moffat.
John Moffat.-
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ayeshatabani
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Hi Sir,
In this example the cost of dept of 7% is given. You said in the lecture that it’s the after tax cost of debt. How do we make this assumption?
There is one such question in bpp text as well, where we are using cost of debt without applying the tax rate deduction for WACC calculation. Why aren’t we doing this?
I.e why not 7%*(1-0.25)?
Thankyou
John Moffat
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By definition, the cost to the company has to be after tax (unless the question specifically says that it is pre-tax).
I can’t comment on the question in the BPP text without seeing it, but multiplying by 1-t is only relevant if it is irredeemable debt. If it redeemable debt then the cost of debt is the IRR of the after-tax flows.
ayeshatabani
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Thankyou, makes sense.
However, why isn’t the treatment same for irredeemable debt too?John Moffat
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Because the pre-tax cost of debt is the return to investors and the return to the investors is the IRR of the pre-tax flows. The cost to the company is the IRR of the after-tax flows, and will not equal the return to investors x (1-t) unless the redemption amount is equal to the current market value (which is unlikely).
This is unlikely to be a problem for AFM, but if it worries you the look back at the relevant FM (old Paper F9) lectures, because this is a Paper FM point.
ayeshatabani
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