Cost of long-term funds - part 3

In this lesson

1. 0:00 Types of debt and their cost structures
2. 0:52 Cost of debt for bank loans
3. 2:24 Why debt is cheaper than equity
4. 3:22 Cost of debt for irredeemable bonds
5. 5:04 Cost of debt for redeemable bonds
6. 7:29 IRR formula and calculation method
7. 8:06 Worked example: calculating redeemable debt IRR
8. 11:43 Cost of convertible debt and redemption values

About this lesson

You'll work through bank loans, irredeemable bonds, redeemable bonds, and convertible debt, understanding why each requires a different approach and how tax relief affects the final cost. The core principle is straightforward: the cost of debt is the interest rate adjusted for tax relief, since interest payments are tax-deductible. For bank loans, this is simply the interest rate multiplied by one minus the tax rate. For irredeemable bonds, you apply the same logic but divide by the market value of the bond. Redeemable bonds are more complex—you'll use the internal rate of return (IRR) formula to find the discount rate where net present value equals zero, typically by testing two discount rates (commonly 5% and 10%) and interpolating between them. The video emphasises practical exam technique: keep calculations clean by working with whole numbers rather than decimals, always pick your initial discount rates strategically, and remember that one NPV should be positive and one negative for the formula to work. For convertible bonds, the process mirrors redeemable debt, but you must identify the redemption value as the higher of either the cash redemption amount or the market value of shares at conversion. This content is directly relevant to FM, AFM, and strategic papers where capital structure and cost of capital underpin investment appraisal and financial decision-making.

Duration: 13m