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I wanted to know how do we calculate cost of debt of a bond when the market price of a bond is not mentioned in the question.
For eg:
Bond A has a nominal value of $100 & the interest on the Bond A is 6% per year before tax and they will be redeemed in six years’ time at a 6% premium to their nominal value.What is the cost of debt?
You cannot be asked to calculate the cost of debt without being told the market value of the debt (unless of course they are issuing new debt at par).
If you think you have found such a question as either a past exam question or a question in the BPP Revision Kit, then if you tell me which question I will explain where you are mistaken.
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There is a question in BPP Kit – YGV Co where;
Bond is issued at a par value of $100 per bond and it would pay interest of 9% per year, payable at the end of each year. The bond would be redeemable at a 10% premium to their par value after 10 years.
Now in this question, no market value is given but it has told the issued value of $100 whereas:
I have seen in many questions that the bond is redeemed either at nominal value or premium to their par value.
This is exactly as I wrote in my previous reply in brackets.
There are no bonds currently in issue. They are planning to issue them at their par value of $100 per bond, and the issue price is therefore effectively the market value. It is only when calculating the cost of debt for bonds already in issue that the MV will obviously be different than the par value and therefore has to be given in the question.
As far as the redemption is concerned, all questions will have the redemption at either the par value or at a premium. Unless they are irredeemable bonds or are convertible bonds then there is no other way of redeeming them!!
Have you watched my free lectures on the cost of debt finance? If not then I do suggest that you do. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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