Page 320 - FM Integrated WorkBook STUDENT 2018-19

Chapter 17

4.3 Irredeemable debt

I I(1 – t)
k d = ––– ‘k d(1 – T)’ = –––––––
MV MV

k d = debt holders’ required rate of return

I = annual interest starting in 1 year’s time

MV = ex-int market price of the loan note

‘k d(1 – T)’ = cost of debt to the company

T = rate of corporation tax

Question 11

Cost of irredeemable debt

Bishop Co has in issue 6% irredeemable debt quoted at $105 (ex-interest). The
corporation tax rate is 30%.

Calculate the return required by the debt providers and the cost of debt to
Bishop Co.

Kd = I/MV

Kd = ($100 × 6%)/$105 = 0.057 or 5.7%

Kd (1 – T) = I (1 – T)/MV

Kd (1 – T) = ($6 × 0.7)/$105 = 0.04 or 4%

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