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Question 8.1: Lim Associates plc issues £20 million loan capital on which ...

Lim Associates plc issues £20 million loan capital on which it pays an annual rate of interest of 10 per cent on the nominal value. The issue price of the loan capital is £88 per £100 nominal value and the tax rate is 20 per cent. The loan capital is due to be redeemed in four years’ time at its nominal value.

What are the annual cash flows for this issue?

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The cash flows for this issue of loan capital will be as follows:

Cash flows
£m
Year 0 Current market value (£20m × (88 ÷ 100)) 17.6
Years 1–3 Interest payable (£20m × 10%) (2.0)
Year 4 Redemption value (£20m) + Interest (£2m) (22.0)

To derive the cost of loan capital to the business, the trial and error approach that is used in calculating the IRR can be used.

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