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BI co has in issue 8% irreedemable bonds quoted at 86% ex int.the rate of corporation tax is 25%;personal tax is to be ignored.what is the return to investors?
86/8=10.75%
The answer for irredeemable bonds in terms of return to investors will be market price divided by coupon rate gives percentage return.mrjonbain – your answer is upside down!
The return to investors is the coupon rate divided by the market value.
8/86 x 100 = 9.30%
Sorry, You are right.I don’t know how I made that mistake.Must have not been properly awake.
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Sir, why we igonering corporate tax? only personal tax need to be ignore.
did not understand properlay
Ke = i(1-t) / Ex market priceFirstly, Ke is the return to shareholders, and you are asking about debt borrowing!!
Tax has no effect at all on either the shareholders required return or on the cost of equity – dividends are not tax allowable.With regard to debt, Kd is the return to investors and investors receive the full interest – company tax is irrelevant.
If looking at the cost of debt to the company (which is NOT what was being asked in the questions above) then the tax is relevant, because the company gets tax relief on the interest. The cost to the company is I (1-T)/MV (but only, of course if the debt is irredeemable – if it is redeemable then you have to calculate the IRR. For return to the investor you use the pre-tax flows; for cost to the company you use the after tax interest flows).
I do suggest that you watch the free lectures on this!
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