Example 10 – Pennant The return earned by Pennant is presently 17.5%, this represents a beta value of 1.5. The return on short-dated government bonds is presently 10%. Required What is the expected market return? Example 11 – Agger plc Presently market return is 16%. Agger earns a return of 12% and has a beta value of 0.5. Presently market return is 16%. Agger earns a return of 12% and has a beta value of 0.8. Required What is the present risk-free return? CHAPTER 5 – COST OF CAPITAL 85 KD – THE COST OF DEBT The cost of debt is the rate of return that debt providers require on the funds that they provide. We would expect this to be lower than the cost of equity. The value of debt is assumed to be the present value of its future cash flows. Terminology 1. Loan notes, bonds and debentures are all types of debt issued by a company. Gilts and treasury bills are debt issues by a government. 2. Traded debt is always quoted in $100 nominal units or blocks 3. Interest paid on the debt is stated as a percentage of nominal value ($100 as stated). This is known as the coupon rate. It is not the same as the cost of debt. 4. Debt can be: (i) Irredeemable – never paid back (ii) redeemable at par (nominal value) (iii) or redeemable at a premium or discount (for more or less). 5. Interest can be either fixed or floating (variable). All questions are likely to give fixed rate debt. Kd for irredeemable debt
Example 10 – Pennant The return earned by Pennant is presently 17.5%, this represents a beta value of 1.5. The return on short-dated government bonds is presently 10%. Required What is the expected market return? Example 11 – Agger plc Presently market return is 16%. Agger earns a return of 12% and has a beta value of 0.5. Presently market return is 16%. Agger earns a return of 12% and has a beta value of 0.8. Required What is the present risk-free return? CHAPTER 5 – COST OF CAPITAL 85 KD – THE COST OF DEBT The cost of debt is the rate of return that debt providers require on the funds that they provide. We would expect this to be lower than the cost of equity. The value of debt is assumed to be the present value of its future cash flows. Terminology 1. Loan notes, bonds and debentures are all types of debt issued by a company. Gilts and treasury bills are debt issues by a government. 2. Traded debt is always quoted in $100 nominal units or blocks 3. Interest paid on the debt is stated as a percentage of nominal value ($100 as stated). This is known as the coupon rate. It is not the same as the cost of debt. 4. Debt can be: (i) Irredeemable – never paid back (ii) redeemable at par (nominal value) (iii) or redeemable at a premium or discount (for more or less). 5. Interest can be either fixed or floating (variable). All questions are likely to give fixed rate debt. Kd for irredeemable debt
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