Hi tutor, I would like to ask regarding the calculation on tax savings on interest while getting the apv. In the question, strayer 6/02 (bpp revision kit), subsidised loan is 4m out to the total 9m, which will cost 2% below the company’s normal cost of long-term debt finance, which is 8%.
In calculating the tax interest,
Non-subsidised loan is 5m multiply by 8%= 0.4
Subsidised loan is 4m multiply by 6%=0.24
So total interest is 0.64
My question is, why the percentage of the cost of non-subsidised loan is 8% instead of 2%? Because subsidised loan cost 2% below the company’s normal cost of long term debt finance which is 8%, which means subdised loan cost 6%. So, why non-subsidised loan cost 8%??
I do not have the BPP Revision Kit and so I cannot be specific.
However the question as you have typed it does say that the normal cost of long term debt finance is 8% (and the normal cost will be non-subsidised).
The subsidised loan is 2% lower than the normal cost, so that costs 6%.
(Surely the non-subsidised loan cannot possible be costing 2% – the subsidised loan has to be cheaper than the non-subsidised loan precisely because there is a subsidy.)
I want to ask from the same question as aforesaid
In BPP solutions they have used an average of anuuities of 5%&6% to discount the tax shield while Rf is 5.5%
In some questions in BPP they used cost of debt as discount factor instead of Rf to find the present value of tax shield
Please explain what discount rate should we use in tax shield calculations, Rf of kd ?
There are arguments for using either, and always the examiner accept either.
(It is because the tax shield should be discounted at the rate applicable to the level of risk. One argument is that it is risk free – hence the risk free rate; the other is that it carries the same risk as the debt – hence the cost of debt.)
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