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John I agree with yenuar, I have calculated using the alternative method and the NPV is not 28.64 for part b! Please could you post the alternative solution steps in narrative as i understand posting a new video maybe cumbersome, but just a brief narrative so I can understand possibly I am missing something in the calculations I am doing!
I do need to change the lecture because it will not come to exactly the same result. The reason is that that the project is only lasting 5 years – if it lasted for perpetuity then it would be the same.
However, it will be clear in the question if they want you to take and APV approach.
John, if it’s possible, could you please post the alternative solutions to parts b) and c). I’ve tried to work them out but my answers are different from those calculated using the APV…
Or should we just use the APV approach whenever possible?
The question will make it clear if they want APV and if so then you should obviously use that approach.
In Part C of Example 2, why is the tax saving 0.45m for year 1-5 if it is redeemable debt. If redeemable, surely the outstanding balance of debt after 1 year will not be $30m any more, but only $24.5m and interest in the second year will be only $1.2m with tax saving of $0.36m. The outstanding amount of debt reduces each year, thus interest paid and the tax saving will become less as the debt are repaid each year.
I get a total NPV tax saving on interest over 5 to be 1.23m
@jurgenshniek, the $30m is paid back at the end of 5 years. I have never seen this in real practice.
With redeemable debt, only interest is paid each year and the full amount of the principal is repaid at the end of the period (in this case after 5 years).
This is standard for traded debt (and remember we are talking about traded debt)!
@johnmoffat – the lecturer also states that the new WACC is approx 18% (actual is 18.2%), which is what andypandy, garlyliu and I calculated. However, this discount rate gives an NPV of $24.52.
Any idea of where we went wrong?
Anyone to help pls?
I tried part B using WACC and NPV = $24.52M (?equity=1.95 and WACC=18.2%). Has anybody else tried to do part B using WACC? If yes, what is your result?
@andypandy, i tried and got the same answer as yours. anybody knows which part goes wrong?
@andypandy, The problem is this……although the finance for the project is being raised in the ratio 70%/30%, any gain from the project will go to the shareholders and will therefore increase the market value of the equity.
As a result, the gearing will end up being different that 70%/30% (and also the cost of equity will change because of the gearing).
To be able to use WACC you would need to know what the gearing ratio ended up at, and what the cost of equity ended up being.
(You can check is because we have calculated the gain using APV and you can use the M&M formula to get to the new cost of equity)
i get lost failed to follow from e.g 1, bcz it cuts whn we started part b.
Thanks very much. I have got a better understanding. When I read the question first time, I thought we will work out a NPV and then use WACC to discount on solution b and c.
Adjusted Present Value approach is much easier to use in this case.
I think I’m comfortable with gearing and identifying APV versus WACC questions. The problem is the scenarios given and how the information is presented.
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