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1. While calculating the PV of tax shield, do we use the discount rate of the risk free rate!
2. June 2002, Strayer Inc, why was the issue costs not calculated like this :
Debt : $5m * 1/99
Equity: $10m * 4/96Also why was the PV of issue costs not calculated?! Is it because they mentioned that these costs are not tax allowable?!
1. As I explain in the lectures, you can either discount at the risk free rate or at the return on debt. The examiner always accepts either (and says so in his answers) even though they obviously give different answer.
I explain this (and give the reasons) in my free lectures on APV.2. It has nothing to do with being tax allowable or not. It depends on whether the issue costs are payable out of the funds raised or whether they are payable out of existing cash. If the question does not make it clear then state your assumption and you will get the marks. (This is the case in most P4 questions – there is rarely just one correct answer. You need to make assumptions just as you would in real life, and if you state your assumptions and if your workings are clear for the marker to follow, then you get the marks.)
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