FM Chapter 17 Questions – The cost of capital
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Thank you so much for your brilliant lecture Mr John.I failed(44%) FM December 2020.I have a question which i was suppose to calculate Wacc.There were saying the share price grows at 5% for 5 years in perpetuity,the question was on convertible debts.I would like to know if i was suppose to use that 5% growth as growth for calculating cost of Equity too,because i only used the 5% for redeemption purpose only in the exam.
The only relevant of the growth in the share price when calculating the cost of debt is to decide whether on redemption they will be taking cash or taking shares (worth whatever their expected value is after inflating at 5% per annum). Obviously they will be expected to choose whichever is the higher and then cost of debt will then be calculated on that basis.
Thank you so much Mr. John, I now understand clearly. God bless you .
You are welcome 🙂
Hi John,
I am a little bit confuse as to when to use post tax and pre tax when calculating the cost of debt. I did watch your free lectures about a thousand and one times but to avail.
COULD YOU PLEASE HELP IN THIS INSTANCE BY EXPLAINING IT TO ME. Looking forward to your swift response.
The cost of debt is always calculated post tax. It is the return to investors that is pre-tax.
Hi John,
Am so grateful thanks.
You are welcome 🙂
80percent
Hi, I’m confused in Q5, we have 200,000 in issue by nominal 0.5 c, why in responses is multiplied 200,000 by 2.40. I think should be 200,000/0.5*2.40. Am I write? Can you help me please here?
No you are not right.
The question says that there are 200,000 shares. (You would only have been right if the question had said that the nominal (balance sheet value) of the shares was $200,000)
Oooo thank’s a lot, it is tricky, and i should be more attentive
You are welcome 🙂
why is IRR calculated for q3 ?
Because that is how we always calculate the cost of redeemable or convertible debt!
Have you not watched the free lectures on this?
Sir with regards to question 2 chp 17, i dont understand how u got the cube root to b 5. I am getting an answer of 5.5.If i were to round it up it would have been ‘6’.Please explain .
You must be doing something wrong on your calculator. The cube root of 36.0/31.1 is 1.04998. Therefore g is indeed 5%.
hi john for q 3 i don’t understand why choice 90pc for mv
The first sentence of the question says that the market value is 90.
Did you watch my free lectures on this before attempting the test?
hi john for q 2 how do you get 5% for growth 36/31.1is 1.157556 gi am trying to find the cube but not finding it
You do need to have a scientific calculator, and it will have a cube root button.
sir thank you i get it was so worried i would not get it
You are welcome 🙂
dear sir, in question no. 1 why the answer is not 8% they have told in one years time know sir? so the formula will be
D1/Po+G
33.6/420 + 0.05 equals 13%, not 8% !!
ohh thank u so much
You are welcome 🙂
I have a question regarding Quizz question 5. When you compute the MV of debt, you do 200.000 * 90/100 = 180.000$. But but shouldn’t it be multiplied by 100 ? Because the market value of debt is as said 90p.c which is 90%*100 = 90 instead of 0,9.
Therefore, i get a WACC of 7,20% which is not within the answers proposed… It get me confused.
Thanks in advance,
Kr
The market value is $90 for every $100 nominal.
Therefore $200 nominal is worth $180; $300 nominal is worth $240, and so on.
$200,000 nominal is worth 200,000 x 90/100 = $180,000.
Think about it, if the value of $100 nominal is only $90, how on earth can the value of $200,000 nominal be more than $200,000!!!
In question why the share price is taken as 420 instead of 4.20….?
In question.1) why the share price is taken as 420 intead of 4.20?
It doesn’t matter whether you put the share price and the dividend both in $’s (so $4.20 and $0.32) or both in cents (so 420 and 32) – the answer is the same.
(Did you actually watch my free lectures before attempting the test? The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.)
I would appreciate it if I could get a detailed explanation for Question 3. I do not seem to understand how the NPV figures were arrived at. Thank you so much John.
The correct figures are:
At 10%, the NPV = – 90 + (7 x 3.791) + (110 x 0.621) = 4.85
At 15%, the NPV = -90 + (7 x 3.352) + (110 x 0.497) = -11.87
The IRR = 10 + (4.85 / (4.85 + 11.87)) x 5 = 11.45%
Please, has question 3 been corrected?
I do not seem to understand as to how you arrived at the NPVs listed in the correction that comes up after selecting the wrong answer.
I got:
d.f. PV@10% d.f. PV@5%
0 MV (90) 1 (90) 1 (90)
1-5 Int 7 3.791 26.54 4.329 30.30
5 Red 110 0.521 57.31 0.784 86.24
NPV= -6.15 NPV= 26.54
Question one why not 8percent?
By rearranging the formula
I got
re = D(1+g)/(P-g)
You have rearranged the formula wrongly.
If you watch my free lecture, you will see that rearranging the formula gives:
Re = (Do(1+g) / P ) + g
I do suggest you watch the lecture because this is an incredibly common question in the exam!!
Dear John,
Thank you for organizing those quizes. They helped a lot
I was able to significantly improve my knowledges and restore everything I knew before in a short time.
<3 <3 <3
I am pleased they have helped you 🙂
Please I would like to know the formula used to arrive @ the cost of equity for question 1
Question 3
IRR of the flows:
0 M.V. (90)
1-5 Int. 7 per annum (because tax allowable)
5 Repayment 110
In your calculation debt interest is not tax adjusted; i am confused sir. Pls kindly explain.
Sorry – you are correct and it is a mistake.
I will have it corrected – thank you for pointing it out.
question 3 of 5 CHAPTER 17 PRACTISE QUESTIONS
The NPV that i get by using discount factor 10% was 16.22 but not 6.22.
therefore the final answer I get 15.1%
You are correct – the NPV at 10% is 16.22.
However that gives the correct IRR as 14.50%.
Thanks for spotting the error – I will have it corrected.
question 2 of 5 CHAPTER 17 PRACTISE QUESTIONS
Please can you explain why the cost of equity is 12%? how is the calculation done?
thank you
g = (cubed root of 36.0/31.1) – 1 = 0.05 or 5%
Cost of equity = ((36.0 x 1.05) / 540) + 0.05 = 0.12 or 12%
(I am currently entering workings so that when you submit an answer, the software will show the working for the correct answer. So far this is happening for the first 10 tests, but it will happen for all the tests within a few more days 🙂 )
Dear Sir,
I would like to know why 540 is being used instead of 5.40.
Because I have shown all the workings in cents!!!
By all means show them in dollars (dividend = 0.36, MV = $5.40) and you will get exactly the same answer!!!!
The question says that there are 200,000 shares (not 400,000). (It does not say that the nominal value is $200,000)
Therefore the total market value of the equity is 200,000 x 2.40 = $480,000
The market value of the debt is $180,000.
Therefore the WACC = (480,000/(480,000+180,000)) x 15%) + ((180,000/(480,000 + 180,000)) x 7%) = 12.82%
Hi John
Thank you for explaining!
Such is a careless mistake of mine.
You are welcome 🙂
I just read the exact same thing for this. I saw it as $200,000 worth of shares not just 200,000 shares. Which I do all the time, I don’t read the question properly!! At least I know what I’m doing wrong 🙂
The more you make mistakes, then less chance that you will make them in the exam 🙂