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Hi Tutor,
Pg. 17 of the Answers – Appendix 3, much that I don’t understand:
– Why use 11% as the discount/annuity factor to calculate PV of Bahari project cash flows. The project is fully funded by the subsidised loan, which is 2.25% net of tax. Why can’t I use this to get the project PV?
– Then, what is the basis/reason of using 7% as annuity factor for tax shield & subsidy PV. 7% annuity factor also used for Appendix 4 workings, is it for the same reason?
– So, as above, why can’t I directly derive NPV of Bahari project by using the project cost of capital which is 2.25% (?) and so no need to do separate working for PV of tax shield/subsidy?
As you can see, I am quite confused, and for some reason, I’m not able to wrap my head around the above. Please help, thanks.
The question is specifically asking for an APV approach (even though it doesn’t actually mention adjusted present value, it does ask you to use the ungeared cost of equity).
With APV we always discount at the ungeared cost of equity and then add on the tax benefit of the debt raised.
APV is very common in the exam – it is a better approach when there is a substantial change in gearing.
Hi tutor, why tax shield benefit and subsidy benefit are discounted using annuity factor 7%, the one from loan? is it always like that? Thanks
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