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Business valuations and market efficiency

Question 12

Cost of irredeemable debt

A company has irredeemable loan notes in issue trading at $95 cum interest.
The coupon rate is 5% and the rate of corporation tax is 30%.

Calculate the pre-tax and post-tax cost of debt.

Ex interest MV = $95 – ($100 × 5%) = $90

Kd = I/MV

Kd = $5/$90 = 0.056 or 5.6%

Kd (1 – T) = I (1 – T)/MV

Kd (1 – T) = ($5 × 0.7)/$90 = 0.039 or 3.9%

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