Hi Im a bit confused about the incorporation of the tax elements
In example 9 you mentioned that there was no indication of the debt being redeemable, so it is assumed its an irredeemable debt. Hence the formula I(1-T)/MV

In example 10, the debt was a redeemable debt yet you still incorporated the tax element.

There is a formula to calculate cost of redeemable debt
=(I*(1-T)+[{RV-MV}/N]) / [(RV+MV)/2)]
I = Interest
T = tax rate
RV = redemption value
MV = market value
N = Number of years till redemption

Can we use this in exam rather than calculating IRR?

I too am confused in example 9. Per my understanding from the previous videos, we should have taken tax factor in consideration when we were to take company’s cost in consideration. Why have we factored tax in return to investors as well ? (example9- part a)

I do not show part (a) in the lecture. I calculate the cost of debt in order to calculate the WACC and cost of debt always means the cost to the company, which does take into account the tax.

The answer to part (a) is printed in the free lecture notes (as are the answers to all the examples).

In example 10, I used 15% and 10% to calculate the IRR and it gave me 6.631 which seems like a big margin from the 7.51 you got using 5 and 10%. Please advice

Using those two guesses does indeed give an IRR of 6.63%, but as I state in the lectures different guesses will give different answers because the relationship is not linear.

However, they were rather extreme guesses to have used (which is why your answer is so much different). As a very rough guide, always divide the after-tax interest by the market value. For this question it gives 7/105 = 6.67%. The actual IRR will be little bit higher because the redemption is at a premium, but there is no way it is going to be as high as 15% 🙂

Hi teacher, I used 5% and 10% then I have the same result like yours (7.51%) but when I used 10% and 15% as the friend above, but my result is [10% + (12.47 / 18.52)* 5% ] = 13.36%
Please advise! Thank you!!!

On page 150 of the Sep-Dec 2019 lecture notes for example 10 the Ke is given as 14.68 instead of 14.75, it looks like someone copied down the answer from example 9.

In example 10 I tried this by myself and instead of using 5 and 10% to calculate the cost of debt, I used 5 and 8%. This gave me the answer, 8.02%. Have I done something wrong or should I stick to multiples of 5 or something?

Sorry I made an error and tried it again but got 7.30% as opposed to 7.51%. do the estimates of cost of equity differ depending on the numbers you use for discounting? By that much?

I think you mean differences in the cost of debt (not the cost of equity).

The answer (and I do say this in my lectures) is that the estimate of the cost of debt can certainly differ by that much, because the relationship between the rate of interest and the NPV is not linear. If it is were than 1% different, then it almost certainly means that you would have made a mistake.

I’m a bit confused. During calculations of WACC, you can use both book value and market value. It is obvious that the book value will differ from the market one. In the video, the market values of equity and debt are used in WACC calculation. Which approach should be used during the exam?

Hi john I have a question on example 9, we are asked to work out the return to investors on debt this would be 8/92 : 8.69% , we worked out the cost of debt to the company didn’t we as 6.09% (after tax)

radekzamulacz says

In pdf materials, there is copy/paste mistake in answers for example 10 (WACC section).

BR

Adam

afuakay says

Hi Im a bit confused about the incorporation of the tax elements

In example 9 you mentioned that there was no indication of the debt being redeemable, so it is assumed its an irredeemable debt. Hence the formula I(1-T)/MV

In example 10, the debt was a redeemable debt yet you still incorporated the tax element.

Is there any reason for this? or kindly clarify

Thanks

John Moffat says

We always incorporate the tax saving in the calculation of the cost of debt.

With redeemable debt we take the IRR of the after tax flows. With irredeemable debt we take the after tax interest dividend by the market value.

rajeshops says

Sir, please advise, in CBE exam can we use Excel formula to calculate the IRR and use it for answers?

prateek101 says

There is a formula to calculate cost of redeemable debt

=(I*(1-T)+[{RV-MV}/N]) / [(RV+MV)/2)]

I = Interest

T = tax rate

RV = redemption value

MV = market value

N = Number of years till redemption

Can we use this in exam rather than calculating IRR?

John Moffat says

No, you cannot use that formula in the exam. That formula only gives an approximation.

tusharfarmah says

In question 9 Part a question is asking to calculate Return to INVESTORS on Debt. so why are we taking tax into account for the same ?

We generally take tax into account when we calculate cost of capital for company. Right ?

John Moffat says

For part (a) I do not take tax into account. Only for part (b).

Pratibhapahwa4313 says

I too am confused in example 9. Per my understanding from the previous videos, we should have taken tax factor in consideration when we were to take company’s cost in consideration. Why have we factored tax in return to investors as well ? (example9- part a)

John Moffat says

I do not show part (a) in the lecture. I calculate the cost of debt in order to calculate the WACC and cost of debt always means the cost to the company, which does take into account the tax.

The answer to part (a) is printed in the free lecture notes (as are the answers to all the examples).

Pratibhapahwa4313 says

Thank you for such prompt response Sir!

I misunderstood. thank you for the clarification 🙂

John Moffat says

You are welcome 🙂

fadhili101 says

In example 10, I used 15% and 10% to calculate the IRR and it gave me 6.631 which seems like a big margin from the 7.51 you got using 5 and 10%. Please advice

John Moffat says

Using those two guesses does indeed give an IRR of 6.63%, but as I state in the lectures different guesses will give different answers because the relationship is not linear.

However, they were rather extreme guesses to have used (which is why your answer is so much different). As a very rough guide, always divide the after-tax interest by the market value. For this question it gives 7/105 = 6.67%. The actual IRR will be little bit higher because the redemption is at a premium, but there is no way it is going to be as high as 15% 🙂

thuyly134 says

Hi teacher, I used 5% and 10% then I have the same result like yours (7.51%) but when I used 10% and 15% as the friend above, but my result is [10% + (12.47 / 18.52)* 5% ] = 13.36%

Please advise! Thank you!!!

John Moffat says

The NPV’s at 10% and 15% are both negative, so the IRR cannot possibly be more than 10% !!!

The IRR = 10% – (12.47/18,52 x 5%) = 6.63%

freddie1980 says

On page 150 of the Sep-Dec 2019 lecture notes for example 10 the Ke is given as 14.68 instead of 14.75, it looks like someone copied down the answer from example 9.

freddie1980 says

Actually it looks like the whole answer in example 10 was copied down from example 9

John Moffat says

Thanks – I will check and have it corrected.

However the answer in the lecture I think is correct.

gkane says

Hi there John,

In example 10 I tried this by myself and instead of using 5 and 10% to calculate the cost of debt, I used 5 and 8%. This gave me the answer, 8.02%. Have I done something wrong or should I stick to multiples of 5 or something?

Kind regards

gkane says

Sorry I made an error and tried it again but got 7.30% as opposed to 7.51%. do the estimates of cost of equity differ depending on the numbers you use for discounting? By that much?

John Moffat says

I think you mean differences in the cost of debt (not the cost of equity).

The answer (and I do say this in my lectures) is that the estimate of the cost of debt can certainly differ by that much, because the relationship between the rate of interest and the NPV is not linear. If it is were than 1% different, then it almost certainly means that you would have made a mistake.

dennyvik says

I’m a bit confused. During calculations of WACC, you can use both book value and market value. It is obvious that the book value will differ from the market one. In the video, the market values of equity and debt are used in WACC calculation. Which approach should be used during the exam?

Thank you in advance!

daudsikaona says

How do answer a question that indicates a company has outstanding loan notes?

John Moffat says

Loan notes are the same as debentures and loan stock – they are debt borrowing.

Have you not watched the lectures on the previous chapter where I explain this?

manishatai says

Hi john I have a question on example 9, we are asked to work out the return to investors on debt this would be 8/92 : 8.69% , we worked out the cost of debt to the company didn’t we as 6.09% (after tax)

John Moffat says

Correct for both 🙂

suzcooney says

Thank you ! Amazing Videos

John Moffat says

Thank you for your comment 🙂