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ACCA P4 The Capital Asset Pricing Model Example 11

VIVA

ACCA P4 lectures Download P4 notes

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Comments

  1. ashiktamot says

    April 23, 2018 at 6:35 am

    hi John , i cant find the lecture explaining APV method…Does this mean it is not important for exam?

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    • John Moffat says

      April 23, 2018 at 6:47 am

      It is incredibly important for the exam and is covered in the chapter and lectures on the impact of financing.

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  2. Damian says

    February 23, 2018 at 8:35 am

    Hi Sir,

    In the lecture at the very end the statement that you made:
    “The formula assumed any debt borrowing is irredeemable”

    You are talking here about The Asset beta formula correct?

    Thank you

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    • John Moffat says

      February 23, 2018 at 8:40 am

      Yes. It is because the formula really comes from M&M and they assume debt is irredeemable.
      It doesn’t affect calculations in the exam, but is relevant if you were asked to state the assumptions made in the calculations.

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      • Damian says

        February 24, 2018 at 10:23 pm

        Thank you

      • John Moffat says

        February 25, 2018 at 10:09 am

        You are welcome 馃檪

  3. kkhatani says

    November 22, 2017 at 8:58 pm

    Hi, in this lecture you have calculated the equity betas of 2.75 and 2.04 but when you use a calculator by using the formulas as you have presented them we would not agree on the figures. Should the asset beta formula not simply be flipped around and multiplied by the asset beta to get an equity beta? as this was not mentioned in this lecture. thanks

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    • John Moffat says

      November 23, 2017 at 8:50 am

      I don’t understand you. The answers are correct, and ‘flipping’ the formula round is just basic maths – you hardly need to rewrite the formula first!

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      • kkhatani says

        November 23, 2017 at 7:48 pm

        I’m trying to say using a calulator as per the calculations you have provided you would not get to get the equity betas of 2.75 & 2.04. you would have needed to flip the asset beta formula and then multiply it by the asset beta. Maybe i’m wrong but there was no mention of the need to flip the formula over, and the way the formula was written out might have misleaded other candidates.

      • John Moffat says

        November 24, 2017 at 8:18 am

        I am grateful for your comment, but I do disagree – partly because it is basic arithmetic, but also because it is revision of something already learned for Paper F9.

  4. cyh says

    July 22, 2016 at 10:55 am

    hi Sir, do we need to know more about Adjusted present value (APV)?

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    • John Moffat says

      July 22, 2016 at 5:51 pm

      What is in our lectures is enough for APV (as long as obviously you are practising all of the questions in your Revision Kit).

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      • dinovo says

        August 11, 2017 at 11:02 pm

        Dear Sir, regarding APV, I have got a few questions which I hope you could help me with. Suppose a company has been quoted a price of around 拢1m to acquire an asset which will be used for a 5 year project. The company is likely to finance the project through borrowing bearing annual interest payment, the loan is priced at 12M LIBOR rate (1.77%) plus 2%, the issue costs are expected to represent 2% of the total funds raised. My questions are:

        1. When calculating the interest payment for tax shield, should we take (1.77% + 2%) x 拢1m or we need to take into account the issue costs and take (1.77% + 2%) x 拢1m x 100/98, ie. are the issue costs already included in 拢1m or we need to add it into 拢1m to get the amount of total funds raised?

        2. When calculating NPV, should we use 拢1m as an initial investment or 拢1m x 100/98? In other words, should the issue costs be included in initial investment or it is treated differently to the amount necessary for the project (拢1m)?

        3. If we don’t include the issue costs when calculating NPV (if we only use 拢1m as the initial investment), why do we need to to deduct the issue costs at the end when we calculate the APV?

        Thank you so much Sir.

      • John Moffat says

        August 12, 2017 at 8:57 am

        1. It depends on the wording of the question. If it is not clear then state your assumption and you will get the marks.

        2 and 3 The issue costs are effectively an extra cost of doing the project and so need subtracting when getting the NPV. It wouldn’t make any difference to the final answer whether you subtracted them from the base case NPV or separately at the end, but we subtract them at the end because they related to the method of financing rather that to the project itself.

      • dinovo says

        August 12, 2017 at 1:39 pm

        Dear Sir,

        Thank you for your answer but I am a bit confused, if we assume that 拢500 is needed for the investment and the issue costs (say 拢100) are paid out of total finance raised, yes we have to pay interest on 拢600 but when calculating base NPV, what is the initial investment, 拢500 or 拢600 and why? Could you please help me clarify? Thank you Sir.

      • John Moffat says

        August 12, 2017 at 4:13 pm

        For the base case NPV the investment in the project is $500.

        However in total it did end up costing us $600, and we show the extra $100 issue costs in arriving at the adjusted PV (we take the base case NPV, add on the tax saving on the interest, and subtract the $100 issue costs).

      • dinovo says

        August 13, 2017 at 2:41 am

        Thank you so much Sir, that indeed solved my question.

      • John Moffat says

        August 13, 2017 at 8:54 am

        You are welcome 馃檪

  5. nounrattanak says

    March 26, 2016 at 2:33 am

    Hi, P4 lecturer!

    I have a question regarding example 2 of chapter 16.

    First, why the cash flow of the combined companies is 35, 42, 47, 52, and 207?

    It’s my understanding that, including synergy benefit of 10 p.a, it should be 38, 45, 50, 55, and 210 instead.

    Another question is related to the comment saying that “Nairobi will therefore gain 4.” I don’t know where this conclusion comes from. Please explain to me the detail and the rational.

    Note that it is in Chapter 16 THE VALUATION OF ACQUISITIONS AND MERGERS, whose video podcast is not available.

    I am looking forwards to seeing your explanation.

    Thanks,

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    • John Moffat says

      March 26, 2016 at 7:34 am

      It is assumed that the synergy benefit is pre-tax, and so after tax will be 7 per year.

      The gain should be 7 not 4 – thank you for spotting the typing error, I will have it corrected.

      (Incidentally, although there are no lectures for Chapter 16 because the techniques involved are covered in other chapters, I have recorded a lectures working through a few Question 1’s from recent exams. The problem is more one of approach than extra technical knowledge and I try to deal with this in the lectures. They are linked from the main P4 page.)

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      • nounrattanak says

        March 28, 2016 at 3:43 am

        Thank you very much, Mr. Moffat.

        Your reply is so earlier than expectation that I couldn’t believe it. I’m really delighted with your short and concise explanation; it’s really helpful to me.

        With regards,

        Rattanak

      • John Moffat says

        March 28, 2016 at 8:17 am

        You are welcome 馃檪

  6. fass239 says

    December 8, 2015 at 11:09 pm

    Hi, after Minute 9, should we have not converted the ungeared asset beta of 1.57 to a geared(as per oil company gearing) beta to be used in CAPM of part a)’
    Thanx

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    • John Moffat says

      December 9, 2015 at 6:43 am

      No, because at that point we are considering the situation when the project is all equity financed. In which case the equity beta will be the same as the asset beta. The lecture does go on to explain this.

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  7. Ania says

    November 20, 2015 at 5:51 pm

    Dear Sir,

    In relation to part b where the project is financed by equity and debt in a ratio 50:50, I understand that this will change the gearing of the company and so the financial risk of the company will change.
    I thought that we use APV method where the financial risk of the company changes as a result of taking up a project.
    Please explain the reason the WACC method has been used in this question and not APV.

    Many thanks for all your lectures, they are invaluable source of knowledge.

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    • John Moffat says

      November 20, 2015 at 6:07 pm

      There is no rule about when to use APV rather than discount at the WACC.

      However it is regarded as being a better approach when the gearing of the company as a whole is changing significantly (not just the gearing of the project).

      These days, the examiner tells you if he wants you to use the APV approach 馃檪

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  8. anonymous says

    July 3, 2015 at 5:30 pm

    Awesome Lecture!!

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  9. sogan0 says

    February 7, 2015 at 6:15 pm

    im grasping so far thanx Lecturer

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  10. lakeside says

    November 28, 2013 at 4:13 pm

    Dear Tutor,

    Please what if we are are an Oil company and we were going to invest in a Ship project, hence which means the business risk may be different from that of the company. The project will be all Equity financed and the current WACC is 10%. We were also given a similar company’s data in the shipping business. BUT Finally, the examiner drops a bomb and say after careful analysis, the company found out that taking on the project will not change the existing risk of the company.

    In this case above, what should be the discount factor to use?

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    • John Moffat says

      November 28, 2013 at 4:16 pm

      It would be impossible for the examiner to do this. The only way that the existing risk would not change would be if oil carried the same risk as ships. If that were the case then using the asset beta for ships would still be the right approach (because the asset beta for oil would be the same)

      If you see a question and you think he is doing this, then I really would read again very carefully 馃檪

      PS If you are asking questions of me, then it is better to ask in the Ask the ACCA tutor forum for P4. It is not always possible to check all the comments made below lectures – there are so many lectures – but questions in the Ask ACCA Tutor forums are always checked and answered.

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      • lakeside says

        November 28, 2013 at 4:55 pm

        Thanks John, I will post future questions in the Ask ACCA Tutor forums.

        Many Thanks really for this

  11. rmracca says

    October 30, 2013 at 10:29 am

    Hi Tutor ,
    Where can I find lectures relating to Valuations of mergers and acquisitions – Type 1,2,3 acquisition ?

    Many thanks,
    RMR

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    • John Moffat says

      October 30, 2013 at 10:57 am

      There are no lectures on this yet. However the course notes contain all you need.

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  12. rmracca says

    October 29, 2013 at 12:28 pm

    Thanks for a great lecture.
    But was wondering where can I find lecture relating to the alternative way mentioned at the end of lecture?

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    • John Moffat says

      October 29, 2013 at 1:37 pm

      The alternative way is adjusted present value, which is dealt with in chapter 12.

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      • rmracca says

        October 29, 2013 at 3:21 pm

        Thank you 馃檪

      • John Moffat says

        October 29, 2013 at 3:35 pm

        You are welcome 馃檪

  13. questforknowledge says

    July 9, 2013 at 2:05 pm

    opetuition tutors are great but you are marvellous: but where is the section for the alternative way

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  14. tinashe says

    May 30, 2013 at 10:18 pm

    I HAVE UNDERSTOOD THOUGH I MUST ADMIT ONE THEN NEEDS TO PAY PARTICULAR ATTENSION TO THE GEARING RATIO. That you need to understand like in the example above that when he says gearing ratio (debt to equity) of 0.4, it doesn’t mean 40% debt and 60% equity. I mean that was my initial confused assumption Admin. which would have also been in the exam too!

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    • naveed says

      August 14, 2015 at 9:11 am

      dont b panic .its simply means debt is 40 % of equity ultimately equity is 100%

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  15. babarali47 says

    April 27, 2013 at 9:45 am

    Once again, Great lecture!….but, what is that alternative?

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  16. yenuar says

    March 11, 2013 at 2:40 am

    I’m not sure about one thing…In Example 11 the asset beta equals to 1.57, equity beta is 1.80. What about the difference of 0.23? What does it represent if we assume that debt beta is 0?

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    • John Moffat says

      March 11, 2013 at 9:08 am

      Gearing makes the shares more risky and therefore the equity (share) beta is greater than the asset beta (which is the risk if there was no gearing). The fact that we assume the debt beta to be zero is irrelevant in that more gearing will always make a share more risky.
      There is no special significance attaching to the difference of 0.23.

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      • euxuph says

        September 30, 2014 at 5:51 pm

        I am a bit confused about the using the asset beta in part a. as the question asked, “100% equity financed”, where I thought only equity beta has to be used. It got further confusing when equity beta was used to calculate the equity holders return in part b and c.

        my question is, why equity beta was used for calculation of equity holders required return in part b and c; why not in part a?

      • John Moffat says

        September 30, 2014 at 7:46 pm

        If there is no gearing, then the equity beta will be the same as the asset beta. (More gearing makes share more risky and therefore when there is gearing the equity beta is higher than the asset beta. However, when there is no gearing the equity beta is equal to the asset beta.)

        Since the equity beta measures the risk to shareholders, it is always the equity beta that determines the return required by shareholders. The equity beta was used in part (a) – it is equal to the asset beta since is is 100% equity (i.e. no gearing).

  17. bunnywong1986 says

    May 23, 2012 at 10:55 am

    the lecture is great but i wonder why we don’t consider tax effect on culculating wacc? why not culculate wacc as:[ve/(ve+vd)]*ke+[ve/(ve+vd)]*0.75*6%?

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    • bunnywong1986 says

      May 23, 2012 at 11:01 am

      @bunnywong1986, oh sorry i see, 6% is after tax relief

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  18. asadxsiddiqui says

    May 22, 2012 at 8:31 pm

    Awesome explanation !!

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  19. nuan says

    March 20, 2012 at 2:48 pm

    HELP! I can’t see the rest of the ecture. It stops at around 21mins, after (Ke) for part b of the question

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  20. mwachilale says

    September 27, 2011 at 8:02 pm

    This lecture has clarified most of the errors that I was making on this topic.

    Thank you. I hope I will not repeat the same mistakes during exams.

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