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Dear John,
I have the following question.
In some of the questions to calculate the market value of bonds/loan notes, before tax cost of debt is provided and also the tax rate. When I calculate the annual interest payments for loan notes I use tax shield and also adjust the cost of debt for tax (1-t). But when checking the answer, I see they don’t deduct tax for interest and use before tax rate. So what’s the strategy shoul be?
Thank you!The market value is determined by investors – it is the present value of their expected receipts discounted at their required return.
The investors are not affected by company tax, and so tax is irrelevant when looking at their expected receipts, and tax is irrelevant when considering their required rate of return (which is therefore equal to the pre-tax cost of debt).
I do suggest that you watch my free lectures on the valuation of securities, because I stress this point (which is commonly asked in the exam).
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
Ah, thank you, I see. So when it is asked to calculate the value of bonds for the company for example to calculate wacc, I will deduct tax for interest and use the tax adjusted rate. And when it is asked to calvulate just market value of bond, I will not deduct.
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