ACCA FM 2026: The Cost of Debt Mistake That Scores Zero in WACC
Using the perpetuity formula on redeemable debt scores zero
The single most expensive cost-of-capital error in FM: treating redeemable debt as if it were irredeemable. The examiner is blunt — applying the perpetuity formula to redeemable debt earns no marks at all. Redeemable debt needs an IRR of its after-tax cash flows. Get that reflex right and the whole WACC follows.
What the examiner actually reports
In FM, the cost of debt is where WACC answers quietly fall apart. The perpetuity formula, Kd = I(1−T) ÷ MV, is only ever for irredeemable (undated) debt. For redeemable debt you must find the internal rate of return of the bond's after-tax cash flows — the interest each year and the redemption value at the end. The examiner has stated plainly that using perpetuity on redeemable debt scores zero.
The next mark leak is the coupon rate. Weaker candidates simply quote the 7% coupon as the cost of debt. The coupon is not the cost of debt — the market's required return is, and it comes from the current market price, not the nominal value. Forgetting to tax-adjust the interest compounds the error.
Then the weightings. WACC must use market values, not book values. And reserves are not a separate source of finance — they are already inside the market value of equity, so counting them again double-counts equity and distorts the whole calculation.
Finally, the theory trap. Candidates assert that adding debt always lowers WACC because debt is cheap. That ignores the rising cost of equity as gearing climbs, plus bankruptcy and financial-distress risk. A one-line "more debt is cheaper" with no caveat rarely earns the discussion marks on offer.
Worked example: cost of redeemable debt
A bond has a 7% coupon, $100 nominal, redeemable at par in four years, currently trading at $95. Tax is 20%.
Wrong: treat it as irredeemable — 7 × (1 − 0.20) ÷ 95 = 5.9%. This ignores the $5 gain on redemption and understates the cost of debt (and your WACC).
Right: find the IRR of the after-tax flows — outflow $95 now, interest of $5.60 (7 × 0.8) in years 1–4, plus $100 redemption in year 4. That IRR is roughly 7.1%. The redemption gain pushes the true cost above the running-yield shortcut.
What to do
Read "redeemable" as "do an IRR". The moment a bond has a redemption date, the perpetuity formula is off the table — set up the after-tax cash flows and interpolate.
Weight on market values only. Equity at market price (reserves already included), debt at market price per $100, then never let a book value near the WACC.
Tax-adjust the interest, not the coupon rate. Cost of debt is post-tax and market-driven; the coupon is neither.
The bottom line
FM's pass rate sits around 50%, and cost of capital appears in almost every diet. The perpetuity-versus-IRR choice is a single decision worth several marks — and it's free once the reflex is trained. Know your debt type before you touch a formula.