The cost of capital (part 2) - ACCA (AFM) lectures
YouTube video
75 Comments
A
Arosh·
What an amazing lecturer. Solved all the problems which were in my head <3 Wishing you all the best
J
John MoffatTutor·
Thank you for your comment :-)
A
Aditya·
Wonderful lecture Mr. John!
A
Antoinette·
Thank you so much Sir for the insightful lectures. Ive been exempted from FM and in my previous studies I’ve used a financial calculator to determine IRR. Please bear with me, I do have a somewhat ‘basic’ question in relation to the guesses I.e. the 10% and 15% range used per the tables in the example per the lecture.
Though I fully follow the thought process and principle of the calc. How do we decide which % to go based on the number of years?
Would be grateful if any other student also has an input on this please.
Thank you.
A
Antoinette·
I think my query has been responded to in part 3 of the lectures by similar questions from other students. We use the spreadsheet method anyway in CBE. It would be good to know though.
J
John MoffatTutor·
Yes, you do use the spreadsheet formula (and this is all explained in the last chapter of the lecture notes).
R
RaMoses·
Hello, Love the video I was wondering how you would use the IRR function in excel to get your answer instead?
J
Jamie·
Thanks for this. Is the answer to example 8 correct please? I don't understand where 18.28 come from, I have it as 16.28? with the IRR coming out at 10.02%. The answer in the back of the notes also appears to multiply 6.06 & 10.22 rather than add them? Then the answer is 11.86. Bit confused. Thanks.
J
John MoffatTutor·
There is an error in the lecture - the total is 16.28 and not 18.28.
The printed answer is correct (the 'x' sign should be a '+' sign but the workings are all correct.
K
Keverne·
Hi sir, I got the same answer as the student above (10.02%). I cannot seem to get the same answer in the lecture notes (11.86%). If the answer should add 6.06 and 10.22, should it be 6.06+(-10.22) = -4.16? but then the answer would be 2.7% . I'm experiencing confusion to get the final answer. Appreciate it if you could correct me, thanks!
J
John MoffatTutor·
Many congratulations on having passed :-)
A
Anna·
Thanks for a clear explanation! Passed FM with your lectures. Happy to know a lot while studying AFM now
M
Muhammad Hamza·
Is the nominal value always assumed to be $100 in exam, regardless it's redeemable or irredeemable debt
Because it wasn't mentioned in the example and not sure if it's explained or not in the video or I might have missed it out
J
John MoffatTutor·
Yes, unless obviously the questions says differently.
Z
Zakkz·
Sir, what if the loan notes are convertible into equity ? Is that portion important for AFM exam ? It was asked in the last FM exam.
J
John MoffatTutor·
Convertible loan notes are examinable (just as they are for Paper FM also).
Z
Zakkz·
Thanks for the reply. Is it covered in the AFM section or should I go to FM lectures to revise it ?
D
Dimpi·
Hey John,
In example 8 why can't we directly use the formula for redeemable debt; {Interest+ [(Redeemable Value- Net Proceeds)/no. of years]} / [(Redeemable Value+Net Proceeds)/2?
J
John MoffatTutor·
Because that is not the way we calculate the cost of debt. Given that the market value the debt is the present value of the future receipts, the only correct way of arriving at the cost of debt is to calculate the IRR as shown in the lecture.
T
Trus·
Hi Sir,
through using ACCA spreadsheet platform IRR function, I got 10.67% for part (a) and 9.03% for part (b). Is my answer acceptable?
J
John MoffatTutor·
Yes, of course :-)
N
nkeng·
Hello sir Moffat
Can I depend on these well explained notes and video for the December 2022 session??
??
J
John MoffatTutor·
Yes you can :-)
N
nkeng·
Thanks sir
J
John MoffatTutor·
You are welcome.
P
parvathinair195·
Hi,
I had a quick question regarding the calculation of annuity factor in Example 8 (Redeemable Debt). I know this can be obtained from the Annuity Table provided during the exam, but is there any way to calculate this on the Scientific Calculator to save some time? Any tips would be appreciated! Thanks in advance.
M
MANISH·
how will i value a company share where 100% earnings is retained ?
J
John MoffatTutor·
No company will retain 100% of its earnings for ever. At some stage they will pay a dividend.
Certainly they may retain 100% for a few years and therefore only pay dividends at some time in the future, in which case the MV will be the PV of rite future dividend as always.
M
MANISH·
why we discount only dividends to arrive at MV of share and not retained earnings , as retained earnings brings growth in MV of share too ?
J
John MoffatTutor·
Retained earnings are used to expand the company which leads to increases in profits which in turn leads to increases in dividends.
I do suggest that you watch the relevant Paper FM (was F9) lectures, because this is all revision from Paper FM.
M
mbopentuition·
is 16.86 not 18.86
J
John MoffatTutor·
What is ???
M
Muhammad·
The fall of NPV from 6.06 to negative 10.22. Video reference @ 20:07
J
John MoffatTutor·
You are quite correct and I have made a silly mistake in the lecture – I must re-record it. I should have used 16.28 instead of 18.28 and so the answer is slightly different (but the printed answer in the lecture notes does have the correct answer). Sorry about that.
(Although (and I am not using this as an excuse) I would still have almost certainly got full marks in the exam despite the mistake because the approach was correct and the difference it makes is minimal (and the answer is of course only ever an approximation anyway ? ))
M
Mishern·
Hi John,
I couldn't reply to your post on 12 Jan 2021 at 13h44 below, so am doing so here.
I believe there to be a tiny error in the answer to Example 8 (b) on page 125 of the lecture notes - the math operator in the denominator of the term in brackets ought to be "+" not "x" --> "6.06 + 10.22" not "6.06 x 10.22".
A quick question regarding how we might calculate the IRR in the CBE: Microsoft Excel has NPV and IRR formulae that enable one, in my opinion, to use the power of Excel and set out the answer in an easy-to-follow way. Are either of these formulae available in the CBE spreadsheet functionality?
A
Anon·
Hi,
So since we're considering both the rate and the premium with IRR in redeemable, am I correct to assume that the Cost of Irredeemable debts is in fact effective rate of interest?
A
Anon·
Sorry, cost of redeemable debts.
Great lecture. Very clear!
J
John MoffatTutor·
Yes - it is the effective rate of interest the company is paying. (The effective interest being received by the investor is the IRR of the pre-tax flows)
A
Anon·
Okay. Thank you. ^^
J
John MoffatTutor·
You are welcome :-)
J
jocelynjm·
Hi John,
Thanks for the excellent lecture.
Just wondering are we allowed to take a financial calculator into the exam? Thanks heaps!
J
John MoffatTutor·
It is a scientific calculator that you need for the exam, not a financial calculator.
Two things - one is that whatever calculator you use it must display only numbers and not letters. The other is that you still need to show workings because it is the workings that get the marks and not the final answer.
Thanks for the comment :-)
J
jocelynjm·
Thank you :)
J
John MoffatTutor·
You are welcome :-)
G
Gnoii·
Dear sir,
In case of making loss in fiscal year, is there still tax relief for the interest paid or a recalculation of interest rate for business review?
Please kindly enlighten me this.
Thank you very much.
J
John MoffatTutor·
It would only be relevant if the business as a whole made a loss (not just the project in question). However for the exam we assume that we always get the tax relief on the interest.
A
Ashru Ashrf·
since the premium of 10% can be accounted as an interest, wouldn't the premium be tax allowable too?
A
Ashru Ashrf·
sorry, the answer was already in the comments.
J
John MoffatTutor·
No problem - I am pleased that you found the answer :-)
B
Bhumit Soni·
Hello Sir,
In redeemable debt part b, as suggested if take +85 and other cashflows negative the NPV turns out to be Positive.
in this case will the company issue debentures?
whereas if we take -85 the NPV is -ve.
Will the decision change?
J
John MoffatTutor·
What decision? :-)
As far as the IRR is concerned it will not change - the IRR is when the NPV is equal to zero and minus zero is still zero :-)
B
Bhumit Soni·
Decision about whether the Gplc shall issue debentures or not.
I have this understanding that if IRR is greater than Cost of capital then the company shall issue the debentures and if the case is vice versa then the company shall refrain from doing so.
Due to this understanding i had a doubt that if we get different IRR(+ve/-ve) with different approaches which shall be considered?
please correct me if i have understood it incorrectly.
J
John MoffatTutor·
But what you have written is not the case. If the company needs to raise money then they have the choice of issuing debentures or using equity finance. We do not compare with the cost of capital (the cost of capital will change anyway depending on how finance is raised).
As far as the IRR is concerned I repeat what I said before - the IRR will be the same regardless of the approach taken!
It may help you to watch my free Paper FM (was F9) lectures on this, because this is revision of Paper FM.
B
Bhumit Soni·
Thank you very much. It did help clear my concept.
J
John MoffatTutor·
You are welcome :-)
C
Chris·
With redeemable debt, why cant you claim tax relief on any premium you pay at the end of the term?
I.e. take out a loan with a nominal value of $100 and 10% premium, at the end of the term you pay $110. Why cant you claim tax relief on thr extra $10 which is effectively interest paid on maturity?
W
Wajahat·
how did we got 18.28 i just can,t seem to understand this concept
J
John MoffatTutor·
It is the difference between the NPV at 10% (+6.22) and the NPV at 15% (-10.22).
If you have forgotten IRR calculations then looking at the relevant MA (F2) and FM (F9) lectures will remind you.
K
Kwame·
But the difference between +6.06 - (-10.22) = 16.28? So how come it is 18.28 in this instance?
I don't get it at all
J
John MoffatTutor·
You are quite correct and I have made a silly mistake in the lecture - I must re-record it. I should have used 16.28 instead of 18.28 and so the answer is slightly different (and the printed answer in the lecture notes does have the correct answer). Sorry about that.
(Although (and I am not using this as an excuse) I would still have almost certainly got full marks in the exam despite the mistake because the approach was correct and the difference it makes is minimal (and the answer is of course only ever an approximation anyway :-) ))
R
Ruth·
thanks for clearing that up.
J
John MoffatTutor·
No problem :-)
A
asher100·
With regards to example 8, part a, I don't understand why the PV should equal zero. Shouldn't the PV be positive for an investor to want to invest?
J
John MoffatTutor·
Good heavens, no !!
The amount investors will be prepared to pay is the PV of the future expected receipts discounted at their required rate of return.
I suggest that you watch the Paper FM lectures on the valuation of securities, because this is revision from Paper FM (F9).
K
kim·
Please what's the difference between yield to maturity and cost of debt
J
John MoffatTutor·
The first is the return to investors, the second is the cost to the company.
T
Temitope·
How did you get 18.08?? This is my first time seeing IRR calculated like so.
T
Temitope·
gotten it.
C
Chris·
With redeemable debt, why cant you claim tax relief on any premium you pay at the end of the term?
I.e. take out a loan with a nominal value of $100 and 10% premium, at the end of the term you pay $110. Why cant you claim tax relief on thr extra $10 which is effectively interest paid on maturity?
J
John MoffatTutor·
Because that is UK tax law!
The interest is tax allowable but the premium is not tax allowable.
S
Salwa·
It’s 16.86 not 18.86
N
Nigel Wilson·
For example 8(a) the answer is 11.86% not 11.66%. The movement in NPV is -16.28 and not -18.28, due to which the answer you getting is 11.66%
J
John MoffatTutor·
Thanks - I will correct it when I have time.
However the answer printed in the lecture notes is correct at 11.86% :-)
Though I fully follow the thought process and principle of the calc. How do we decide which % to go based on the number of years?
Would be grateful if any other student also has an input on this please.
Thank you.
The printed answer is correct (the 'x' sign should be a '+' sign but the workings are all correct.
Because it wasn't mentioned in the example and not sure if it's explained or not in the video or I might have missed it out
In example 8 why can't we directly use the formula for redeemable debt; {Interest+ [(Redeemable Value- Net Proceeds)/no. of years]} / [(Redeemable Value+Net Proceeds)/2?
through using ACCA spreadsheet platform IRR function, I got 10.67% for part (a) and 9.03% for part (b). Is my answer acceptable?
Can I depend on these well explained notes and video for the December 2022 session??
??
I had a quick question regarding the calculation of annuity factor in Example 8 (Redeemable Debt). I know this can be obtained from the Annuity Table provided during the exam, but is there any way to calculate this on the Scientific Calculator to save some time? Any tips would be appreciated! Thanks in advance.
Certainly they may retain 100% for a few years and therefore only pay dividends at some time in the future, in which case the MV will be the PV of rite future dividend as always.
I do suggest that you watch the relevant Paper FM (was F9) lectures, because this is all revision from Paper FM.
(Although (and I am not using this as an excuse) I would still have almost certainly got full marks in the exam despite the mistake because the approach was correct and the difference it makes is minimal (and the answer is of course only ever an approximation anyway ? ))
I couldn't reply to your post on 12 Jan 2021 at 13h44 below, so am doing so here.
I believe there to be a tiny error in the answer to Example 8 (b) on page 125 of the lecture notes - the math operator in the denominator of the term in brackets ought to be "+" not "x" --> "6.06 + 10.22" not "6.06 x 10.22".
A quick question regarding how we might calculate the IRR in the CBE: Microsoft Excel has NPV and IRR formulae that enable one, in my opinion, to use the power of Excel and set out the answer in an easy-to-follow way. Are either of these formulae available in the CBE spreadsheet functionality?
So since we're considering both the rate and the premium with IRR in redeemable, am I correct to assume that the Cost of Irredeemable debts is in fact effective rate of interest?
Great lecture. Very clear!
Thanks for the excellent lecture.
Just wondering are we allowed to take a financial calculator into the exam? Thanks heaps!
Two things - one is that whatever calculator you use it must display only numbers and not letters. The other is that you still need to show workings because it is the workings that get the marks and not the final answer.
Thanks for the comment :-)
In case of making loss in fiscal year, is there still tax relief for the interest paid or a recalculation of interest rate for business review?
Please kindly enlighten me this.
Thank you very much.
In redeemable debt part b, as suggested if take +85 and other cashflows negative the NPV turns out to be Positive.
in this case will the company issue debentures?
whereas if we take -85 the NPV is -ve.
Will the decision change?
As far as the IRR is concerned it will not change - the IRR is when the NPV is equal to zero and minus zero is still zero :-)
I have this understanding that if IRR is greater than Cost of capital then the company shall issue the debentures and if the case is vice versa then the company shall refrain from doing so.
Due to this understanding i had a doubt that if we get different IRR(+ve/-ve) with different approaches which shall be considered?
please correct me if i have understood it incorrectly.
As far as the IRR is concerned I repeat what I said before - the IRR will be the same regardless of the approach taken!
It may help you to watch my free Paper FM (was F9) lectures on this, because this is revision of Paper FM.
I.e. take out a loan with a nominal value of $100 and 10% premium, at the end of the term you pay $110. Why cant you claim tax relief on thr extra $10 which is effectively interest paid on maturity?
If you have forgotten IRR calculations then looking at the relevant MA (F2) and FM (F9) lectures will remind you.
I don't get it at all
(Although (and I am not using this as an excuse) I would still have almost certainly got full marks in the exam despite the mistake because the approach was correct and the difference it makes is minimal (and the answer is of course only ever an approximation anyway :-) ))
The amount investors will be prepared to pay is the PV of the future expected receipts discounted at their required rate of return.
I suggest that you watch the Paper FM lectures on the valuation of securities, because this is revision from Paper FM (F9).
I.e. take out a loan with a nominal value of $100 and 10% premium, at the end of the term you pay $110. Why cant you claim tax relief on thr extra $10 which is effectively interest paid on maturity?
The interest is tax allowable but the premium is not tax allowable.
However the answer printed in the lecture notes is correct at 11.86% :-)