Free ACCA & CIMA online courses from OpenTuition

Free Notes, Lectures, Tests and Forums for ACCA and CIMA exams

December ACCA Exam results

Comments & Instant poll >>

20% off ACCA & CIMA Books

OpenTuition recommends the new interactive BPP books for March 2025 exams.
Get your discount code >>

Reader Interactions

Comments

  1. Hi Sir,
    After watching video, I’m still confused about below and don’t know why:

    If the new finance finance is to be raised entirely from Debt, then 2nd thing will happen- Higher gearing will increase the level of risk for SHs and SHs likely to require higher rate of Return, which will increase the cost of equity.
    -> since we have decided to raise the finance from Debt, why should we consider if the cost of equity increase or not? Even the coest of equity increase, we’re not going to finance from the equity.

    Besides, why the Total WACC will decrease in this case?
    Thanks.

    • If the cost of equity increases, then the company will have to pay a higher dividend otherwise the market value of the shares will fall (because shareholders determine the market value, as explained in earlier chapters). Therefore whatever the company is investing in will have to earn enough to both pay the debt interest and in addition pay the extra dividend needed.

      The question in your last sentence is explained in full in the lectures on the following chapter.

      • The lectures cover everything needed to be able to pass the exam well.
        However, do make sure you by a Revision Kit from one of the ACCA approved publishers – they contain lots of past exam (and other exam standard) questions for practice, and practice is vital to passing the exam.

  3. Dear sir,

    We have the following example in notes:

    “If, for example, the new finance is to be raised entirely from equity, then two things will
    happen.
    Firstly, the level of gearing in the company will change, and this clearly will effect the
    weightings when we come to calculate the WACC.
    Secondly, higher gearing will increase the level of risk for the shareholders”

    The second point says that there will be higher gearing for the increased equity. I think If we increase the equity only then it will result in lower gearing, which will reduce the level of risk for the shareholders. The shareholders will be happier than before and they may require lower return.
    Your comment needed here 馃檪
    Thank,

    • You are quite correct – it is a typing error. You are the first to notice it 馃檪

      The first line should read “if, for example, the new finance is to be raised entirely from debt”. I will have it corrected immediately. (However, my discussion in the lecture is correct)

      Thank you for spotting it 馃檪

  4. Great lecture Sir,

    Calculating WACC in this example (pilot paper) it is said that Droxfol Co has no overdraft. If it had an overdraft how would we calculate the total market value of it in order to come to WACC.

    Second, if it had an overdraft how do we deal with this kind of debt (redeemable or irredeemable debt), may be with a small example I can understand my silly question. Thanks in advance John.

    • The WACC is the cost of long-term finance and so overdraft borrowing is only relevant if it is intended to be long-term. A bank loan would be a better example.

      The market value is the same as the value in the SOFP (because it is not tradeable).

      The cost of the debt is simply the interest rate x (1 – T). (because there is no premium payable on repayment at the end of the loan).

  5. Hi john,
    Debt is apparently the cheapest source of finance, but as you said that raising debt makes the company more risky & thus shareholders increase their return, so the cost of equity will increase, however if we do not give an increased return to the shareholders, the share price will decrease,but how does it affects a company? I mean they have already raised money through those shares & invested it and as you said that, we are actually looking at, what would be the cost of raising more finance.
    So effectively, the company only has to bear the cost of debt, if they raise further loans. Even though the shareholders will require higher dividends or returns, but the company does not necessarily have to increase the return, as the money from those shares is already invested, even if the share price falls, what does the company loses? Unless it needs to raise further equity finance.

Leave a Reply