Pilot Paper dec 2006 Q.No 4

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    muhaimin
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    Hi,

    Hope you all are in good health. Many many thanks to open tuition for guiding us through out the ACCA career, you have been mighty mentor specially for those who are doing jobs and studies simultaneously/ who do not find time to take classes in centers.

    Please refer to the title, It asks to calculate us expected cost of capital after taking additional finance, it has given us the yield diagram through which the risk free rate can be identified. Kindly see the solution it finds current yield on debt as 3.45%, I am baffled how he came to it?

    Please reply.
    Thanks
    Abdul Muhaimin


    Avatar of John Moffat
    John Moffat
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    Sorry – I missed this before.

    It is a very very bad question (and it was from the examiner who has now been replaced).

    What he has done is read from the graph for the retail sector, the cost of 3 year debt – from the graph it seems to be about 3.85%.

    Then he has taken the yield spread for the retail sector (for 3 year debt and AA- credit rating) which is 40 basis points.

    He has subtracted 40 basis points from 3.85% to get a ‘risk free’ rate of 3.45%

    The trouble is that what he has done is not strictly correct anyway. Just because this companies credit rating is AA- does not mean that is the case for all retail sector companies. However, later he has added on the spread relevant to the change of credit rating, which sort of ‘cancels’ the problem.

    (You can see why the ACCA replaced this examiner :-) )


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    muhaimin
    Participant
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    How can he do this to us? he already suggested 4.2 as risk free on new yield (which seems to be perfectly ok) then how come 3.85 is not a previous debt’s risk free.

    Its good that he’s been removed ;) Shishir also looks like a tough and technical guy but still he gives lots of marks available to get 50…june 2012 is a good example. Anyways Thank you so much john for your precious time.


    Avatar of John Moffat
    John Moffat
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    I agree with you :-))

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