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Dear sir,
R plc has in issue $400,000 8% bonds, redeemable in 5 years time in premium of 10%. Investors have a required rate of return of 12% p.a.
the corporate tax rate is 35%
ask for the market value of the debt.
and the answer is 364,840BI co issue 8% irredeemable bonds quoted @86 ex-int, the rate of corporate tax is 25% ?personal tax to be ignored), and the return to investors is 9.3%
I calculate these 2 over and find that they both ignore the tax effect but why?
Shouldn’t tax be taken into account when making a debt valuation?Finally, about the EOQ mcq, company has monthly demand for 7,500 units and EOQ 6000 units, how to calculate ” at what level of inventory should a new order being placed”?
Thank you so much.
Tax is always irrelevant when valuing the debt.
It is the investors who determine the market value, and company tax does not affect them – they receive the full interest.
Tax is only relevant when calculated the cost of debt, because the company gets the benefit of the tax relief on this interest.The inventory question says that it takes 30 days to receive an order. With 365 days in a year and a demand of 12 x 7500 = 90,000 per year, they therefore need to place an order when they have 30/365 x 90,000 = 7397 units left in inventory.
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