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Sir I have a question on exam 2005 Sleepon Hotels INC 50 mark question on how the TAD,working capital and the market value of debt has being calculated?
First question: We do not use the cost of debt to appraise projects. We use the WACC, unless there is a major change in the gearing in which case we use an APV approach.
I explain all this in my free lectures.
Second question:
The answer shows the workings for the TAD. It is 25% reducing balance as per the question.
The question says that working capital of 50M will be required at the end of year 1 (i.e. at time 1). It also says that flows are a current prices and are rising at 3% a year.
Therefore the cash required at time 1 is 50x(1.03) = 51.5M
At time 2 they will require another 3%. 51.5 x 0.03 = 1.55M
They now have total working capital of 51.5 + 1.55 = 53.05M. At time 3 they require another 3%. 53.05 x 0.03 = 1.59M, and so on.The question tells you in note (ix) that the current market value of debt is $93 per $100 nominal. Therefore the total market value is 460 x 93/100 = 427.8M
All of these points are really basic revision of Paper FM (old Paper F9), and I do suggest that you watch my AFM lectures and the relevant FM lectures.
Sir thank you for your reply, but according to the answer they have claimed a TAD for the year of disposal as well and the working capital must be realized at end of the project life and isn’t it year 5 according to the question?and why isn’t the tax charge of $105.46 not being included in the appraisal?
If the variable cost is $30 and if the price is set at variable cost plus 100% how do we find the price of this?
In case if the project was fully funded by debt cant we still use the cost of debt to appraise the project?
First question:
105.46 is not a tax charge – I am assuming that you are meaning the tax written down value of 105.47, but this is the tax written down value – not a tax charge! If you are asking why there is no balancing charge or allowance in the final year, then this is explained in the answer – the fact that the the question says that the proceeds are after tax means that they are after any balancing allowance or charge.Second question:
I assume you are not referring in this question to anything in Sleepon (because your figures do not appear anywhere in the question). However if the price is variable cost of $30 plus 100%, then it is 30 + (100% x 30) = $60 !!Third question:
No we can’t !!!! Raising more debt will affect the cost of equity because of the higher gearing. We must either appraise at the WACC (as in this question), or (as is more likely with the current examiner) if the question asks for it then we must calculate the APV.
Again, have you actually watched my free lectures for the AFM paper (and, where relevant, for the FM paper)??
I address all of your points in my lectures.
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