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Hi
DFE Co has 8% convertible loan notes in issue which are redeemable in five years’ time at their nominal value of $100 per loan note. Alternatively, each loan note could be converted after five years into 70 equity shares with a nominal value of $1 each.
The equity shares of DFE Co are currently trading at $1.25 per share and this share price is expected to grow by 4% per year. The before-tax cost of debt of DFE Co is 10% and the after-tax cost of debt of DFE Co is 7%Why we are using 10% as a discount rate?
Thank you in advanceI assume that you are referring to the calculation of the market price of the loan notes (which is not how you have headed up your post!!).
The market value is determined by investors and is the PV of expected receipts discounted at their required return. Their required return is the pre-tax cost of debt, because investors are not affected by company tax.
I stress this in my free lectures, because it is something that is asked in almost every Paper FM exam.
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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