What Is RV in the Calculation Cost of Debt?
There are many financial variables that business operators must throw into the equation to determine if they are ultimately profitable. It is imperative to have an understanding of each one of these variables so that you know how to maximize them for profit to help the bottom line of your business. One is RV, which, in terms of cost of debt, means "Redeemable Value."
Other People Are Reading
-
Cost of Debt
-
Cost of debt refers to the amount of money that a business pays for the debt on its books. Many businesses operate in debt to get off the ground, or to expand their business ventures. If the cost of debt is manageable, then it will allow them to grow and hopefully one day eclipse the debt on their books. While calculating the cost of debt can be quite complex, depending on the number of debts a business may have, it can be simply illustrated with this example. If a business issues one corporate bond at 10 percent, then its cost of debt would be 10 percent because that is what it has to pay its investors.
Pre-Tax
-
Businesses can look at debt in different ways. Some businesses may wish to calculate the cost of debt before any taxes have been removed. If this is the case, one must merely add the debts together and divide them by the total number of debts. For instance, if a company issued three bonds, at 3 percent, 6 percent and 9 percent respectively, it would add those three together and divide by three.
(3+6+9) / 3 = Cost of Debt. In this equation, that works out to 6 percent.
-
After-Tax
-
A lot of companies also want to look at the cost of debt after they have paid their taxes. The net amount is a better snapshot of what a company is truly making. To find the after-tax cost of debt, you must subtract the tax rate from 1 (1 equaling 100 percent) and multiply the outstanding cost of debt. Using the example of 6 percent from above and assuming the company paid a 30 percent tax rate, the math would read:
.06 x (1.00 - .30) = After Tax Cost of Debt.
.06 x .70 = .042 When multiplied by 100 to get to percentage form this means the company is actually paying 4.2 percent.
Redeemable Value
-
To take the cost of debt one step further, you can add in redeemable value. (Think of this in the same way an annualized percentage rate, APR, is a more accurate snapshot than a base interest rate.) Redeemable value simply means the amount of money that the issued investment is worth. In most cases, this will be corporations' calculating the cost of debt on bonds.
Pre-Tax Redeemable Value
-
The equation from above expands slightly when adding in redeemable value. It reads:
C =[I+(RV-SV) / n] / [(RV+SV)/2]
In this equation, I represents the amount of interest paid for each term, C represents the cost of debt, RV represents redeemable value, SV represents sale value and n represents the term of the debt. (Note that the sale value deducts commissions or other monies that a company paid a brokerage to sell the bond.) For example, say a company issued a $500,000 bond at 10 percent per year, for five years, and paid a $10,000 commission on the sale.
C = [$50,000+($500,000 - $490,000) / 5] / [($500,000+490,000) / 2]
This equation works out to 10.5 percent.
Post-Tax Redeemable Value
-
The only difference in the post-tax equation is that you are going to multiply the previous equation after the tax rate has been deducted. Using the same example as above and assuming a 30 percent tax rate the equation would read:
C =[[I+(RV-SV) / n] / [(RV+SV)/2]] x (1 - .30)
C = [[$50,000+($500,000 - $490,000) / 5] / [($500,000+490,000) / 2]] x .70
This equation calculates to .074 or 7.4 percent when changed to a percentage. In this manner, the redeemable value helps you calculate the true cost of debt after issuing corporate bonds.
-
References
- Photo Credit business is business - cliche image by Jeffrey Zalesny from Fotolia.com
