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  1. Dear sir,

    In this chapter, we are using:
    “ke” in WACC formula = shareholders required rate of return = cost of equity

    In chapter 15, we used:
    “re” in Growth model formula = shareholders required rate of return = cost of equity

    I want to confirm that whether we can use “re” and “ke” interchangeably in exam in formulas or not as both means the same?

    PS: We also used “re” in Gordon鈥檚 growth approximation which means something different(It is return on re-investment here). It has nothing to do with the above “re” and “ke”.

    • Yes – Ke and Re on the formula sheet are the same.

      With regard to Gordon’s growth approximation, Re is the return on re-investment. If we are not told what this is, then we do assume it is the return on equity, but usually we are told it.

  2. Hi John,

    When calculating the WACC why do we mutliply equity/total with the cost of equity and debt/total with the cost of debt. I think this might just be purely mathematical and not related to financial management as it just involves calculating a weighted average but I am just a little confused.

    Thanks.

    • Why are you confused? We need to know the overall cost of capital – some comes from equity and some comes from debt and therefore we calculate the average.

      As I say in the lecture, the reasoning for using the WACC (and when not to use the WACC) is covered in the subsequent lectures.

  4. Urgent Help !! You have said that in irredeemable we only take account of tax but not in redeemable debts but in Example 10 in cost of debt calculation. Year 1-6 Int (10 * 0.70) = 7p.a ?? Why have you used tax as it’s redeemable debt.
    In last lecture example 8 with redeemable debt you didn’t take into account tax
    1-5 int 6pa .
    Why is is different ??

      • You have misunderstood – we always take account of tax whether it is redeemable or irredeemable, if we are calculating the cost of debt to the company.

        If we are looking at the return to investors, then we ignore tax (whether redeemable or irredeemable) because company tax does not affect them.

        What I said was that it it is irredeemable, then the cost to the company is the return to investors multiplied by (1 -t).

        If it is redeemable then that does not work, and to get the cost to the company we have to calculate the IRR of the flows using the after-tax interest (but the repayment at the end is not tax allowable).

      • I really appreciate your prompt response. Now I have fully understood . Many many thanks Sir !!!!

  7. Thanks John for this good work.
    Now I have got a problem,could you kindly explain to me the differences between these words because im totally lost; ex int, ex div, cum div and cum int.
    I totally get lost when you start talking about these words.
    Thanks again.

    • ex int and ex div are the market values of debt and of equity assuming that interest and dividends have just been paid.

      cum int and cum div are the market values assuming that interest and dividend are about to be paid.

      The cum values are the ex values plus the interest or dividend about to be paid.

      In the exam, values are always ex div and ex int unless told differently.

  8. Sir/Madam,

    I have one question suppose a company XYZ Ltd has cost of debt & preference shares @ 8% and equity shares of face value Rs 10 each which will be issued at a premium of Rs 10 each and also the Co. is having a requirement to raise Rs 200,000, the expected EBIT of the Co. is Rs80,000.The tax rate is 50%; what will be the Co’s EPS, the financial break level and indifference level of EBIT.

  9. Dear Sir,
    I have a different kind of question.can you just please help me to solve the following question.

    Assume that ABC Corporation has the following capital structure. 30% debt, 10% preferred stock, & 60% equity. ABC Corporation wishes to maintain these proportions as it raises new funds.it’s before tax cost of debt is 8%, it’s cost of preferred stock is 10%, & it’s cost of equity is 15%. if the company’s marginal tax rate is 40%. what is ABC’s WACC?

    Thanks Sir

    Randolph

    • The cost of debt is 8% x (1-0.4) = 4.8%
      The cost of preference shares is 10%
      The cost of equity if 15%

      To get the WACC you multiply each cost by the proportions (30%; 10% and 60%) and add them up.

      I do suggest that you watch the free lectures on WACC.

  10. hi! sir could please explain here the concept of perpetuity..i was trying to attept a question relating cost of capital and i could not find the correct answer.here is the qustion:
    Q: Z has 10,000 shares in issue, dividends for the next five years are expected to be
    constant at 10 cents per share and then grow at 5% per year to perpetuity; cost of
    equity 15%. CALCULATE MARKET VALUE?

    • Perpetuity means for ever.

      I assume that you have watched the free lecture on the valuation of securities. In which case you will know that the market value of a share is the present value of the future expected dividends.
      In this question, you can calculate the present value of the first 5 years of dividends by discounting the 10c a share using the annuity factor for 5 years at 15%.

      Once you get to the perpetuity (which is from year 6 to infinity) you use the first formula on the formula sheet. However, this formula gives the present value now assuming that the first dividend is in 1 years time. In this question the perpetuity starts 5 years late (it starts at time 6 instead of time 1) and therefore you have to discount the result from the formula for 5 years at 15% to get the present value.

      Finally, if you add the result of the previous paragraph to the result from the paragraph before, you will have the market value of the share – the present value of all the future dividends.

      (If you have not watched the lecture on the valuation of securities then do, because this question in itself has nothing to do with the WACC, which is what the lecture above is about.)

  11. hello sir,please i need a little clarification on the tax rate for redeemable and irredeemable debt. from my own understanding(i might be wrong) we are still deducting tax of 30%. my question is how do we save on tax with irredeemable debt and not save tax on redeembale but yet we still deduct 30%..i think i am confused and have it all mixed up.
    As usual thanks for the great lectures.

    • We save tax on both redeemable and irredeemable. However in both cases we only save tax on the interest payments. With redeemable debt there is also the repayment, but we do not save tax on the repayment – only on the interest each year.

  12. Hello Sir, Just wanna ask one thing while calculating cost of debt, you have assumed the interest to be 7 p.a. shouldn’t it be 10? because in example 8, while calculating the same thing you have ignored tax. I’m abit confused where we should ignore tax and where we should consider it. Waiting for your answer.
    Thanking you in anticipation.
    Rehan 馃檪

    • I think you must have skipped through the lecture too quickly (or else you have not downloaded the course notes, which makes the lecture impossible!).

      When we are calculating the return to the investor then tax is not relevant – they investor receives the full interest.

      When we are calculating the cost to the company then tax is relevant – the company gets tax relief on the interest which makes the net cost lower.

      I assume that you have downloaded the Course Notes (otherwise it is pointless watching the lectures 馃檪 ) in which case you will see that the requirements for both examples are (a) calculate the return to investors, and (b) calculate the cost of debt to the company.

      I have done the same thing in both examples.

    • Not quite. There is only one way of calculating the WACC.
      The calculation of the cost of equity can be in two ways – using the dividend growth model or using the capital asset pricing model (depending on the information given) – both are covered in our Course Notes and lectures.

  17. Dear John,

    In example 10 of chapter 17 of OT notes – IRR= 5%+12.59/25.06*5%
    I’m bit confused because we first discounted at10% and then we guessed d.f @ 5% because of negative NPV at 10%, comparing this against example 8 shouldn’t IRR be 10%+12.59/25.06*5%

    I’m not sure why you’ve used 5% instead of 10%. Please explain

    Looking forward to your reply.

    Thanks

    Castrin

  18. Dear Sir John Moffart,

    You just make things so simple that i now have confidence in mastering this subject. I like it when, in your humour, you pick on Peter, Valentino, Andrea and ‘Hello, Hello’ for lagging in their attention (smiling…) Your lectures are just soooo joyful and beneficial to hear and watch.

    You are indeed a gem and a great asset to producing future generations of capable accountants!
    Please continue with your antics and style of lecturing. They are very effective and I just love them…..

  20. 5% Preference shares ($1 nominal value) 10

    the ex-dividend market value of the preference
    shares is $6路25 million

    what will be the cost of preference shares ????????
    thank you

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