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The cost of capital (part 2) – ACCA (AFM) lectures

VIVA

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  1. 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

    • 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.

  6. 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.

    • 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.

      • 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 ?

      • 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.

      • 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 ? ))

      • 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?

  11. 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.

  13. 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?

      • 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.

      • 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.

  14. 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?

      • 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 🙂 ))

    • 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).

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