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Why when we are raising debt finance by issuing redeemable bonds, e.g 8% 100 bond nominal value, redeemable at 10% premium, when we calculate the NPV the first cash flow at time 0 is negative 100 not positive? And why at the end when we are repaying it it is positive cash flow?
I have one more question on one of the C questions foreign exchange q 287 from BPP Revision kit. The answer doesn’t make any sense to me. Would you be able to explain why they take this amount of receipt?
You are referring to calculating the IRR (as the cost of debt). By all means reverse all the signs – you will get exactly the same IRR. However since when calculating the IRR for projects we always start with a negative flow, it is less confusing if we do the same when calculating the cost of debt.
There is a typing mistake in Q287. The receipt in one month should read 240,000 euros (not 40,000 euros).
Dear John, thank you for your help.
Regarding my first question, my coinfusion started when I was doing question 212 YGV Co from BPP revision kit. In the answer they calculated the cost of debt , in the time 0 they deduct the nominal value. My logic tells me that because the company is issuing the bonds to raise funds, they should receive the 100 nominal value and pay the interest of 9% each year. Am I getting it totally wrong!?
Yes – they do receive 100 and then they do pay the interest.
But that is what I was saying before – by all means set up the flows as:0 inflow 100
1-10 interest (6.90)
10 Redemption (110You will still end up with exactly the same IRR (because the NPV will still be zero whichever way round you show the signs).
It is just that we are more used to calculating IRR’s with the first flow as being negative, but that is entirely up to you.
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