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Cost of capital

3.4 Cost of redeemable debt

To work out the cost of redeemable debt, an IRR calculation is
required

Redeemable debt will create a number of cash flows for the entity.

They are:

 the initial receipt of cash (at market value)

 payments of interest (at the coupon rate) on pre-determined
dates

 repayment of capital (possibly including a premium) on
redemption

To work out IRR

 work out cash flows from borrowing,

 estimate IRR (gut feeling should cost be 5% or 10% or 20%?),

 calculate 2 NPVs either side of estimated IRR (e.g. if estimated IRR = 7.5%
could use 5% or 10%). Hopefully one NPV = –ve and one NPV = + ve,

 calculate IRR using formula.

Interest cash flows need to be calculated NET of tax for the NPV
calculations i(1–T).

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