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Sept 2016 Q22
What is the market value of each loan note?Ring Co also has in issue loan notes which are redeemable in seven years’ time at their nominal value of $100 per loan note and which pay interest of 6% per year.
Ring Co has a cost of equity of 10% per year and a before-tax cost of debt of 4% per year. The company pays corporation tax of 25% per year.
My question is do we take post tax or pre tax cost of debt ? The marking scheme shows that they have taken 4% which is pre tax.
In future you must ask in the Ask the Tutor Forum if you wish for me to answer. This forums for students to help each other.
We always use the pre-tax cost of debt to get the market value. It is because it is investors who determine the market value of debt, and they are not affected by company tax.
I do suggest that you watch my free lectures on the valuation of securities because this is unimportant point for the exam and I explain it in detail with examples.
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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