PV factor whether before tax or after tax to calculate market value of debt

LIlakshmana iyer krishnan11y ago

Qn9 Dec2014 MCQ: A company has 7% loan notes in issue which are redeemable in seven years’ time at a 5% premium to their nominal value of $100 per loan note. The before-tax cost of debt of the company is 9% and the after-tax cost of debt of the company is 6%. What is the current market value of each loan note. The answer is based on using PV factor of 9% MV = (7 x 5·033) + (105 x 0·547) = $92·67. My doubt why after tax rate of 6% is not used for discounting, which will give a higher market value of 108.9?

John MoffatTutor11y ago#1

It is the investor who fixes the market value and therefore it is the return required by the investor that matters. The investor wants the pre-tax return (company tax is irrelevant to them). Tax is only relevant to the company and makes the cost to the company lower because of tax relief. I suggest that you watch the free lecture on the valuation of equity and debt, where I stress this point.

LIlakshmana iyer krishnan11y ago#2

Thanks a million, sir for the very prompt reply. I will watch the video, as suggested by you. It is really a great blessing to have somebody to clear doubt and if one goes through all doubts raised by others, that itself will be a great learning. Best wishes and warm regards Krishnan

John MoffatTutor11y ago#3

You are welcome :-)

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