ACCA Financial Management (F9) Certification Practice Exam

To calculate the Cost of Debt for irredeemable bonds without tax, what is the formula used?

1. Kd = i / P0

2. Kd = P0 / i

3. Kd = i x (1 + Rf) / P0

4. Kd = (i - P0) / t

The correct answer is: Kd = i / P0

The formula used to calculate the Cost of Debt for irredeemable bonds without tax is represented correctly in the chosen answer. Specifically, Kd = i / P0 indicates that the cost of debt (Kd) is determined by dividing the annual interest payment (i) by the price of the bond (P0). In this context, the annual interest payment is fixed, and for irredeemable bonds, also known as perpetuities, the bond does not have a maturity date, making the calculation straightforward. The price of the bond (P0) is the current market price, which reflects the present value of all future cash flows from the bond. Thus, the formula effectively captures the return that investors would expect from holding the bond relative to its current price. This approach is essential for investors and financial analysts when evaluating the yield or return on debt securities, as it allows them to understand the cost incurred by the issuer when raising funds through debt issuance. The simplicity of this formula makes it a fundamental concept in financial management, particularly in capital budgeting and investment decision-making processes.