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John,
in this question, we need to calculate the IRR of the loan stock, and we have to choose two yield to guess the IRR and I just choose 13% eg the coupon rate, I still got a negative and positive after minus Market value, however the my IRR is 10% but the answer is just 6%, much difference, so could you pls.advise us how we could guess in this case
Thanks
I assume that at 13% you got a negative NPV and therefore you chose a lower rate for your second guess.
Making different guesses will always give a different IRR (because the relationship is not linear), but to get such a big difference suggests that you have made a mistake in your arithmetic somewhere. Are you sure that you were using the after-tax interest flows?
Also, I would have started with a lower guess than 13%. Because of the tax relief on the interest, the IRR has to be quite a bit lower than 13%. I would have made my first guess at somewhere around 13 (1 – 0.31) = 8.97% (so 9%).
I used the interest before tax flows, as i think i will calculate the kd before tax, is it ok
No – it isn’t OK.
In order to calculate the WACC you need to calculate the cost of debt, which is always after tax.
I do suggest that you watch the free lectures on the calculations of the cost of capital.
John,
May be you get me wrong as imean that i will calculate the irr or kd before tax, but in wacc, i muitiply the kd with (1-t), is that okNo it is not OK.
You can only multiply Kd by (1-t) if the debt is irredeemable.
If the debt is redeemable then you cannot simply use the WACC formula on the formula sheet – you need to calculate the IRR of the after tax flows (and replace Kd(1-t) with this).
I again suggest that you watch our free lectures on the cost of capital (and if necessary the relevant F9 lectures also, because this bit is revision of F9).
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