Jupiter (12/08) – cost of debt

Hi John,

For part c of this question, when the examiner worked backward to calculate the PBIT, I dont understand why we are adding back the interest expense using the Yield to Maturity rate of 4.65% instead of the coupon rate 5.6% for the existing debt. Shouldn’t the interest charged to income statement to be at coupon rate instead of the YTM rate? I thought that YTM rate is purely for calculating the market value of the bond instead of representing an interest expense charged to income statement.

Also, assume another case that this question did not give the Yield to Maturity rate like this, but it gives us the Yield curve of the 4 year bond. In such case, to calculate the current PBIT (before the new bond is considered), will you add back the interest expense using the coupon rate 5.6% or use the interest expense based on Yield curve plus credit risk premium? For me, it is obviously we should add back interest expense using coupon rate….

Thank you