ExpertEasy2 marksMultiple Choice
ACCA · Question 26.4 · Estimating the Cost of Capital
Section B - Case 3: AeroFreight Logistics
Scenario: AeroFreight Logistics operates drone deliveries across Europe and Asia. The company is based in the UK (GBP). It owes a supplier €500,000 payable in 6 months.
Spot rate: €1.1500 - €1.1550 / £1
6-month forward rate: €1.1400 - €1.1460 / £1
UK 6-month borrowing rate: 4% (annual)
Euro 6-month deposit rate: 2% (annual)
Question 4: AeroFreight has irredeemable debt in issue with a nominal value of £100, paying an annual coupon of 6%. The current market price of the debt is £80 ex-interest. The corporate tax rate is 25%.
What is the post-tax cost of this debt?
Section B - Case 3: AeroFreight Logistics
Scenario: AeroFreight Logistics operates drone deliveries across Europe and Asia. The company is based in the UK (GBP). It owes a supplier €500,000 payable in 6 months.
Spot rate: €1.1500 - €1.1550 / £1
6-month forward rate: €1.1400 - €1.1460 / £1
UK 6-month borrowing rate: 4% (annual)
Euro 6-month deposit rate: 2% (annual)
Question 4: AeroFreight has irredeemable debt in issue with a nominal value of £100, paying an annual coupon of 6%. The current market price of the debt is £80 ex-interest. The corporate tax rate is 25%.
What is the post-tax cost of this debt?
Answer options:
A.
4.50%
B.
5.63%
C.
7.50%
D.
6.00%
How to approach this question
Use the formula for the cost of irredeemable debt: Kd = [i × (1 - t)] / P0, where 'i' is the annual interest payment, 't' is the tax rate, and P0 is the current market price.
Full Answer
B.5.63%✓ Correct
For irredeemable debt, the post-tax cost of debt is calculated as:
Kd = [i(1 - t)] / P0
i = 6% of £100 = £6
t = 25% (0.25)
P0 = £80
Kd = [6 × (1 - 0.25)] / 80 = 4.5 / 80 = 0.05625 or 5.63%.
Common mistakes
Forgetting to apply the tax shield (resulting in 7.5%) or dividing by the nominal value (£100) instead of the market value (£80).
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