Part b asks for an estimate of the revised market valuation of the companys debt
In the bpp answer they have calculated the effect by doing this calculation
Effect=0.4/1.044 +0.4/1.044^2 + 0.4/1.044^3=110 basis point reduction
What do they mean by these figures?and they dont add up to a 110 basis point reduction.
When the basis points reduce,does the market value of debt increase or decrease?in this answer they have reduced the market value by 1.1% change
I really appreciate your time and effort
:)
Ask the Tutor ACCA AFM
Q Airline Business(12/07)
12y ago#1I don't know whose answer you are looking at to this question, but it does seem rather confusing. The examiners own answer is (I think) easier to understand.
The first part of your question (0.4/1.044 etc), is calculating the new market value of the existing debt. (The market value if the present value of the future receipts. The coupon rate is 4% so interest is 4 per year on $100 nominal, and the yield/required return is 4.4%).
The solution to that equation is $98.90.
So, for $100 nominal it has fallen to $98.90 - i,e, a reduction of $1.10 (I am not sure I like them calling it a 110 basis point reduction - the examiner doesn't in his answer!)
Thank you Sir John :D
Btw it was from the bpp kit
12y ago#3You are welcome :-)
Dear Sir,
Could you explain why they used yield on bond (4.4%) as the discount factor other than the cost of debt capital (which is (1-tax rate)*yield on bond (3.08%))?
7y ago#5Because it is the investors who determine the market value, and they are not affected by company tax.
I explain this in my free lectures for both AFM and FM (old Paper F9 - this is revision from F9).
You cannot expect me to type out my free lectures again here :-)
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