please tell me when should we gross up the issue costs of debt and equity and if not grossed up do we need to deduct the issue cost element from investment figure. thanks.
If the project needs $80m, and if you only borrow $80m, the bank will not accept, as they don’t work for you for free. So they charge issue cost $xm @2% pa. Total borrowing amount is $80m+$xm, multiply 2% pa is the issue cost amount
If we require $80 for a project, issue cost could 2% of the amount raised, this means we gross up the $80/98 * 2 to get 1.63(issue costs). This meas that we borrow 81.63.
Interest will be chraged on the $81.63 by the providers of funds.
The answers above are both correct.
However read the question carefully. Usually you are told the amount needed for the project and so you will gross up the amount needed to be raised as explained above.
One question I remember though told you the amount to be raised and obviously in the case the issue costs were a % of the amount raised and then the amount available for the project was lower. (It was only one question and is much less likely to be phrased that way)
Thanks John. I was revising from KAPLAN rev kit and some questions needed taking percentage of the investment and some needed grossing up the amount. I couldn’t get the hang of it but thanks for the clarification.
You are welcome
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