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eg 3 years 100 nominal value of debt, interest 8% tax rate 5%, cost of debt 7%
y1 8
y2 8
y3 108or
y1 8(1-T)
y2 8(1-T)
y3 8(1-T) + 100which one is correct? should we include tax effect in calculation of mv of debt?
The first one is correct.
It is investors who determine the market value of debt – it is the present value of their expected receipts discounted at their required rate of return, and they receive the full interest of 8 p.a.. (We always ignore personal/income tax and that tax rate is never given in the exam.)
The rate of company tax is only relevant for the company, and we use the after tax interest when calculating the cost of debt to the company.
How about the market value of debt used in the asset beta formula? Why is it net of tax? Thanks in advance.
It isn’t net of tax.
We do multiply the MV by (1-T) but this is because of Modigliani and Miller.
Hi Sir
I have a question on this for Bonds when we determine the market value is the Present value of future cash flows to redemption discounted at yield as what u mentioned above, is it for both not traded or traded bonds. And for Loans market value is the book value as it is a non marketable debt.
can u explain the difference between non traded and non marketable debt?
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