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Hi John,
For question Burung with APV calculation, I would like to ask some points
1. When we calculate the Base Case NPV with the asset beta and cost of equity, why do we not have to inflate the cost of equity to nominal rate? Lets say the cost of equity using asset beta is 12% and inflation is 2% throughout the project, why don’t we have to calculate nominal rate of cost of equity = 12% * (1.02) ?2. Secondly, I want to ask whether Issue cost of debt form part of the total debt need to be raised with the bank or not? Suppose that the amount of net debt we need for project is 98m, and issue cost is 2% of gross finance. This means that gross finance required is 98 * 100/98 = 100m and issue cost is 2m. Then, does that mean we need to raise 100m with the bank, or we raise 98m only?
Due to this question, then the next question is whether the interest payment will be calculated based on 98m or 100m? According to Burung question, it is based on 98m, which is the net debt.
Thank you
Using the equity beta gives the actual/nominal cost of equity (because it uses the actual risk free rate) and therefore does not need inflating.
The answer should really have calculated in the interest on the gross debt raised and not on the net debt.
However it is a minor point in the question and depends really on assumptions – as always in this exam you should state your assumptions 🙂
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