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Dear Tutor,
I am working through the Kaplan Exam kit for the 2013 June F9 exams and have constantly (mostly…anyway) that my attempts at cluculatin a cost of debt using IRR are not suceeding.On any given question, how do I know whick rates to use for H or L, I see on here that sudents suggest 5% and 10% but then go on to say, it doent really matter as long as I get a positive and negative value for the relavant PV’s. The formulae should work and I should come ot the same answer more or less.
For my own sanity I have attempted to use 5%, and the changed H to 10%, 15% and 20%. I do not get the same answer as in the text (they used 5% and 10%). I am now concerned there seem no difinitive method to select the right rates and am worried I will carry forward error and not get any credit for the answer I produce.
Do you have any suggestions-or does the examiner mark the method as a pose to the answer??There is no definitive method to select the two rates (and there are no ‘correct’ rates).
You can use any two guesses.
However, whichever guesses you use, we are then assuming when we calculate the IRR that the relationship between the NPV and the interest rate is linear. In fact it is not linear (but a curve) and therefore the answer we get is only approximate.
As a result, choosing different guesses will give a slightly different answer. (If you are more than 1% different, then it probably means you have made a mistake, but less than this is quite likely)In the exam you get full marks if you have done the working correctly on your guesses (even though the examiners answers may have made different guesses and therefore be slightly different). However for this reason it is important that you do show your workings properly.
(Even in real life, when we calculate the IRR it is often only approximate (because of the two guesses approach) but this is usually all we need.)
PS For all arithmetic in the exam, it is the approach/method that gets most of the marks. The final answer does not carry many marks at all. It is therefore so important that you show your workings clearly – they can only give marks for the approach if it is clear what you are trying to do 🙂 )
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