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Hello sir, this may be a silly doubt..In appendix 2 ie. calculating yield to maturity of new bonds. Between the years 1-4, im not getting the answer 5.63 as mentioned (interest post tax). Can you tell me how to get the figure?
I do not know where you are finding 5.63 in the answer.
The answer has it as 4.76% and it is arrived at by calculating the IRR of the post tax flows in the normal way. The two guesses that the examiner has used are 3% and 5%, but you could use any two guesses (with different guesses you get slightly different answers, but that is not a problem in the exam).
Sir its mentioned before the percentage (3 & 5) columns within the table itself
I have found it 🙂
It is the after-tax interest paid each year. The coupon rate is 7.5% and the tax saving on the interest is 25%. So the after tax interest cost is 75% x 7.5% = 5.625
I want to clarify this part with you..normally when yield to maturity is being calculated, isnt it only interest? There are solutions ive seen using only the coupon rate and its how ive learnt so far. Any indication as to when to use interest post tax in the table?
No. The yield to maturity is the overall return to investors.
If the debt is irredeemable then it is the coupon rate divided by the market value.
If the debt is redeemable then it is the IRR of the interest and redemption flows.
The examiner was wrong to head the workings as the yield to maturity. The workings are calculating the cost of debt and so we need the IRR of the after tax flows.
All of this is explained in my free lectures and it would be worth your while watching the Paper FM (was F9) lectures on the valuation of securities and on the cost of capital (because this is all revision from Paper FM).
Alright…so whenever im asked to calculate Kd using IRR approach, i should always use interest post tax yes?
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