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Pls help clarify this issue, when calculating the price of a bond, i dont know when to use coupon net of tax and the gross amount. ie if a 5% bond is issued, when do i use 5 or 3.5 as my cashflow.
If you are calculating the cost of debt to the company, then you use the after tax interest (3.5 in your example, if the tax rate is 70%).
If you are calculating the return to the investor (or if you know the return to investor and are calculating the market value) then you use the pre-tax interest (5 in your example).
If cost of debt is calculated then whether it would bl pre tax or post tax ? N if we use 1 minus t to required return to investors woukd it become cost of debt ? confusing.plz explain.
The cost of debt is always calculated after taking account of the tax relief that the company will get on the interest payments.
If the debt is irredeemable, then the cost of debt is Kd (1-t). (Kd is the return to investors which is before tax because the tax relief does not apply to them).
If the debt is redeemable the for the cost of debt you need to calculate the IRR (using the after-tax interest payments).
If you watch my lecture on this then it explains with examples.
Thank u John, i remember reading it but you know how it is, once the text book is closed it becomes a challenge to apply. Cheers and please wish me all the best tomorrow.
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