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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?
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.
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
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