ACCA Financial Management (F9) Certification Practice Exam

Which of the following represents the calculation for the market price of loan notes considering taxation?

1. P0 = i(1 - T) / Kd net

2. P0 = i / (1 - T) * Kd

3. P0 = (i - T) / Kd

4. P0 = i * T / Kd net

The correct answer is: P0 = i(1 - T) / Kd net

The correct calculation for the market price of loan notes considering taxation is represented by the first option: P0 = i(1 - T) / Kd net. In this formula, P0 denotes the market price of the loan notes, "i" represents the coupon interest payment, "T" signifies the tax rate, and "Kd net" is the net cost of debt after accounting for taxes. This calculation accurately reflects how taxes influence the value of debt instruments. The fundamental premise behind this calculation is that interest expenses on loan notes are tax-deductible. Therefore, the effective interest rate that the company pays is reduced by the tax shield provided by the interest expense. The term 'i(1 - T)' indicates the after-tax cash flows from the interest payments, which can be viewed as the actual benefit the debt holder receives after the tax effect is taken into consideration. In contrast, other options do not adequately incorporate the impact of taxation in the context of determining the market price of loan notes. Some might calculate the price without considering the net benefit of tax shields or incorrectly misrepresent how the coupon payments relate to the cost of debt. Thus, the formulation in the first option captures the essential elements required for valuation under the influence of taxation