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Hi Sir,
regarding cost of debt calculated in Avem question.
BPP study text says cost of debt=(1- tax rate) x (risk free rate+ credit spread)
But in Avem question, above rate (risk free rate + 80 basis point) we used to calculate market value of bond. However to calculate cost of debt we use IRR not above formula?
Could you explain why is that?Thank you,
The 4.80% is the pre-tax cost of debt, and this is always what is used to calculate the market value of debt.
When calculating the post-tax cost of debt (for the risk adjusted cost of capital) the answer has multiplied the 4.8% by (1 – tax rate).
(You can find lectures working through the whole of this question, linked from the following page:
https://opentuition.com/acca/afm/afm-revision-lectures/)Yes I am watching lecture, and you say that they use net of 4.8% due to time constraitns, but normaly IRR would be accurate.
So I understand that it depends what is given in the scenario. If they will give required rate of return (which is risk free rate + spread), I multiply by 1-t and use it as cost of debt for WACC calculation, if not IRR calculation has to be performed, is that correct?
hi sir,my question is a bit different i did not understand why did we use wacc in this question, rather that cost of equity as the discount rate. what is the logic or how to understand why i selected wacc?
We always discount at the WACC on the assumption that the gearing of the company will not change significantly. When there is a significant change in the gearing (or when told to) we then use an adjusted present value approach, but that is not the case here.
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