Comments

  1. avatar says

    The Way U do the little parts to reach a full exams question is great.. :)
    However, would it b possible to show us the path the little parts is going whilst doing them?
    Like a Full Exams Question at the Start..and showing how each little parts is going to make us reach there?

  2. Avatar of Mahoysam says

    Mr john, when you asked why the cost of debt is expected to be less, I swear I was shouting: RISK RISK RISK! It is really bad not to be in the classroom to answer your questions :(

    Thanks for the GREAT lectures!!! There is not a single lecture that I finish not understanding something!

    Maha

  3. Avatar of nkmile64 says

    Dear Sir
    thank you for your superb lecture which helped me understand the cost of capital workings and calculations. I certainly hope that by applying that in the exam I’ll probably get the full 9 marks. So, I understand that the correct or should I say the theoretical way of calculating WACC, is by using the market values in order to ascertain the relative weights of debt and equity. What I really don’t understand is why do we have to use the market and not the book values? I mean stock and bond values usually fluctuate in the markets so that even if we manage to achieve a certain capital structure now, it will probably be quite different a few days from now. And even worse, what will happen when a prospective investor (e.g. bank) examines my capital structure? Will they look at the market value or are they going to examine my financial gearing from the book values? I also notice that from the facts of the question itself (Q.1 Pilot Paper) it is assumed that
    even the average industry financial gearing is calculated using the book values. Could you please clarify this subject for me?

    • Avatar of John Moffat says

      I assume that you are happy that when we calculate the cost of equity and cost of debt individually, we must use the market values for the calculation and not the book values (because we are trying to get the best estimate of the cost of raising more equity or more debt).

      When we calculate the WACC, we should certainly use the total market values – that is a fact. The real problem is whether or not this figure is relevant for appraising investments. It is only relevant provided that the capital structure is maintained (we are not bothered about short-term changes – what matters is whether or not it is likely to remain more or less the same in the long-term).

      For Paper F9 calculations we do assume that this is the case (although for written parts you must be able to state the assumption above). When you come to P4 (if you decide to take this option) then we look at how we will appraise if the capital structure does change.

      With regard to ratio analysis and the gearing ratio, it is in fact more sensible to look at it based on market values. Book values are very distorted due to accounting concepts (especially, for example, the fact that non-current asset values on the balance sheet may be nothing like the true values – partly because of the historic cost concept, and partly due to the fact that some assets (e.g. goodwill) do not appear).
      However, gearing based on book values uses information that is more readily available (especially, obviously, for unquoted companies). In the exam, usually you are expected to use book values (but the examiner always makes it clear whether he wants it based on book values or market values). However, if you get the chance in the written parts, you should make it clear that using book values can be misleading. (In fact, using book values usually overstates the level of gearing because usually it will be the equity where the market value will be higher than the book value.)

      Hope that all makes sense :-)

    • Avatar of John Moffat says

      @funlover, when not to use it is when the conditions described do not apply!!!!
      (i.e. if the gearing changes (because of the way the project is financed) or when the business risk changes (because the project is more or less risky))

      The effect of gearing changes is not examined with numbers at F9 (only discussion of Modigliani and Miller). The effect of the project being more or less risky than the company is covered by Capital Asset Pricing Model.

  4. avatar says

    Wonderful explanation- what I really like about your lectures is the logic you are building bit by bit.We cannot find many lecturers like that and we’ll end up cramming whole stuff without knowing what’s going inside.

    I believe the lecturer wants us to think about the knock on effect.

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