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When calculating the cost of equity using IRR formulae , on what basis do we decide and take the two % when discounting the interest value and reedemable value ?
For ex , in this question :
The 8% loan notes of Corfe Co have a nominal value of $100 per loan note and a market price of $103.50 per loan note. Annual interest has just been paid and the loan notes are redeemable in five years’ time at a 10% premium to nominal value.
Corfe Co pays corporation tax at a rate of 20%They’ve taken 5% and 10% as their %’s
IRR = 5 + ((10 – 5) × (10.45/(10.45 + 10.93))) = 7.44%
So my doubt again is – when the interest rate is more than the COE , the MV is more than nominal value and that means our COE should be less than our interest rate %
In this case mv of 103.50 > nominal value 100
and yes the COE calulated using IRR 7.44% is less than the interst rate of 8%
But why are they taking 10% and how are they taking those %’s of 5 and 10 ?Also can we just use the IRR calculation in the spreadsheet to calculate the IRR , will we get marks for it , if we only did that and not the IRR formulae given like the above and without using the 2 diferent %’s ?
Reedemable loan note COE working
Y0 –(103.50) given market value
Y1—6.40 –(8 interest*0.8tax)
Y2—6.40
Y3—6.40
Y4—6.40
Y5—116.40–(6.4+110 ( 10% redeemed at nominal value of 100 ) )
Cost Of Equity–7.27%Using the spreadsheet IRR function i’m only getting 7.27% whereas the mark shceme answer COE to the question is 7.44%
Can you please tell me what mistake i am making here , since the mark scheme also does not state about COE answer being rounded off , they only gave a single answer which is 7.44%
Your not calculating the cost of equity its debt
Are you discounting?????
Using a DF of 10%
T0 /-103.5 /1 /-103.5
T1-5/ 6.4/ 3.791/ 24.26 using an annuity factor
T5 /110 /0.621/ 68.31 using a pv
This comes to a total of
-10.93Using a DF of 5%
T0 /-103.5 /1 /-103.5
T1-5/ 6.4/ 4.329/ 27.71
T5 /110 /0.784/ 86.24
This comes to a total of
10.45So IRR is IRR = 5 + ((10 – 5) × (10.45/(10.45 + 10.93))) = 7.44%
IRR is within a range
Oh yeah sorry , I meant cost of debt
The calculation which I did was using spreadsheet using the IRR function which is available in the spreadsheet just like how the sum function is available.
When calculating the cost of debt using IRR formulae , on what basis do we decide and take the two % when discounting the interest value and reedemable value ?
Pls answer the above
I am saying have you discounted your cash flows??
I can’t see what you have done but you can
Look at what I have done
See above
I’ve done it for you and got 7.44%You always choose either 10 or 5 and then go higher or lower
If the first one gives you – go lower
If the first one is + go higher
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