Skip to content

ACCA Applied Skills · Financial Management · Estimating the cost of capital

Orla Co has 6% loan notes in issue, redeemable at par ($100 nominal) in 5 years. The current market price is $95 ex-interest. The tax rate is 20%. Discount factors at 5% are: annuity years 1-5 4.3295, year 5 0.7835. At 6%: annuity 4.2124, year 5 0.7473. What is the post-tax cost of debt, to the nearest 1%?

The post-tax cost of debt is about 6.0%. It is the IRR of the cash flows: $95 paid now, post-tax interest of $4.80 for five years and $100 redemption. At 6% the present value is about $94.95, matching the price.

  1. A5.0%
  2. B7.0%
  3. C8.0%
  4. D6.0%Correct

Explanation

Post-tax interest is 6 × 0.8 = 4.80. At 5%: 4.80 × 4.3295 + 100 × 0.7835 = 20.78 + 78.35 = 99.13. At 6%: 4.80 × 4.2124 + 100 × 0.7473 = 20.22 + 74.73 = 94.95, which is almost exactly $95. The IRR is therefore about 6.0%. About 7% would be the pre-tax yield, which ignores tax relief.

Did you get it right without looking?

One question tells you little. A timed set on Estimating the cost of capital shows your real accuracy, how long you take and where you lose marks.

Practise Estimating the cost of capitalFree diagnostic mock

More Estimating the cost of capital questions