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It is a question from BPP kit which I don’t understand
Black Co has in issue 5% irredeemable loan notes, nominal value of $100 per loan note on which interest is shortly to be paid. Black Co has a before-tax cost of debt of 10% & corporation tax is 30%.
What is the current market value of one loan note?
My answer:
Interest = $100 x 5% = 5Market value = (5 *0.7) / .(0.10 * 0.7) = $50
But the kit states that the correct answer is $55 which is confusing! Please correct me!
Firstly, it is wrong to multiply the interest and the before-tax cost of debt by 0.7.
It is investors who determine the market value and they are not affected by company tax. (This is commonly tested in Paper FM which is why I do stress this in my free lectures.)
Therefore the MV is 5 / 0.10 = $50 (which I appreciate ends up as the same figure in this case, but the ways in which the examiner tests it checks that you do understand my previous sentence).
However this is the ex-interest MV. This question says that the interest is shortly to be paid and therefore the MV will be cum-interest and will therefore by the ex-int MV plus the interest to be paid, so 50 + 5 = $55.
I do suggest that you watch my free lectures. 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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