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For the working capital requirement, why is the working capital requirement is calculated in Yr 1 but was released in Yr 0…?
Secondly, with regards to the sentence below :-
” although all the working capital is recovered at the end of the project, the flows of working capital are subject to different discount rates when their present values are calculated.”I don’t understand the second part of this sentence.
There is no such thing as year 0 and year 1 – they are points in time. Time 0 is now, Time 1 is 1 year from now, etc..
So the first year starts now – time 0. The second year starts in one years time – time 1. And so on.
With regard to the working capital, the recovery is an actual (nominal) cash figure and so needs to be discounted at the actual (nominal) cost of capital and not at the real cost of capital.
Still confused here…don’t understand what is meant by :-
(1) flows of working capital – refers to the working capital required or released ?(2) subject to different discount rates – isn’t it only 1 discount rate is used (12%) ?
Flows of working capital refer to all flows.
The point is that note (vii) of the question says that working capital has been ignored because all that is invested gets returned at the end (so not net cash flow).
Working capital should have been included because the timing of the flows means that in present value terms, there is an effect. (The answer should have said because of different discount factors rather than saying because of different discount rates – you are correct that there is only the 12% rate)
From the question it says that issue costs related to raising the finance are 2% of the gross finance required.
Isn’t it the issue cost should be 2/100 * 42,970,000 ?
How come the answer showed 2/98 * 42,970,000 ?If you raise 100 finance, then the issue costs are 2, which leaves 98 for the investment.
So for every 98 needed the costs are 2.
Hi John,
I don’t get the how the examiner has come up with the discount rate of 12% which is
“all-equity financed discount rate = 2% + 1.25 * 8% = 12%”
Can you please explain this part?Thanks in advance.
If we are all equity financed (which is what we use for the discount rate with APV) then the relevant beta is the asset beta. The equity beta is 1.5, and using the asset beta formula gives an asset beta of 1.25.
It is then basic CAPM – the risk free rate is given in the question (treasury bills) as 2%, and the market premium is again given in the question as 8%.
I do suggest that you watch the free lectures on CAPM (and if you still have problems, then the F9 lectures on it as well).
Hi john, pls help me out. Annual subsidy benefit = $42,970,000 x 60% x 0·025 x 80%=515.64
my question is why 80% is included in the above calculation.
is it because subsidy benefit are calculated net of tax since the tax rate is 20%. thanks@slibrahim50 said:
Hi john, pls help me out. Annual subsidy benefit = $42,970,000 x 60% x 0·025 x 80%=515.64
my question is why 80% is included in the above calculation.
is it because subsidy benefit are calculated net of tax since the tax rate is 20%. thankssir.. can u pls explain why the 2.5% is used? since we r borrowing at 1% below, why is it not 1.5%?
Because this was asking about the subsidy benefit.
They do pay 1.5%, they would normally have paid 4%, so the subsidy benefit is the difference of 2.5%.
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Hello,
Please provide clarity on the below issues
**The Inflated figure for Sales Revenue & Project Cost in Year 2-4 is quite different from what is in the solution, i got Yr2-39.53, Yr3-53 i.e(1.08*36.60)…for Revenue and Project Cost Yr2-22.84,Yr3-30.62…..i.e(1.04*21.96)
**Why are they not adding back the Capital Allowance or Depreciation.
**Why is the finance Interest Charge not Included in the recomputed Projection?
You are not inflating correctly!! (Look back at the F9 lectures on investment appraisal with inflation if you need to).
The revenue flow at time 2 needs inflating for 2 years, so 36.60 x 1.08^2 = 42.69
The revenue flow at time 3 needs inflating for 3 years, so 49.07 x 1.08^3 = 61.81Same for all of the inflating flows.
Why do you want to add back capital allowances or depreciation??? We would only add back depreciation if we had been given profits after depreciation which is not the case here. Capital allowances have been taken into account quite correctly in the calculation of the tax flows in workings 1.
We never include interest when discount at the WACC. The whole point of discounting at the WACC is to account for all the costs of borrowing (including interest) – to include it in the cash flows would be accounting for it twice.
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Thank you so much
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