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Q19 (Luke Co) - Specimen exam

Vvera_arde12y ago
Dear John, Can you please explain me why was used the before-tax cost of debt of 10% instead of the after-tax cost of debt of 7% when calculating the market value of the loan note? Thank you,
John MoffatJohn MoffatTutor12y ago#1
It is investors who determine the market value of debt, and investors receive the full 10% (we always ignore personal tax in F9). The company has to pay 10% to the investors but gets tax relief on the interest which is why the cost to the company is only 7%. (I really do suggest that you watch the free lectures on the Valuation of Securities where this is made very clear.)
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