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But sir with every other question if the question states that the debt-to-equity ratio remains the same, we use that ratio to calculate the value of the equity of combined company and the benefits to shareholders are calculated based on the increase in equity value if you look at JOSHUA CO (MAR/JUN 23) and CHIKEPE CO (MAR/JUN 18) both have a similar set of circumstances and we calculate gain to them based on increased in equity rather than firm value.
Yes sir, after attempting other questions I noticed the pattern. Thank u for the explanation.
Thank u for the clarification. Sorry for posting a lot of questions. I really appreciate you answering them.
Also, Sir john in the same question it was stated that
“Coeden Co’s latest free cash flow to equity of $2,600,000 was estimated after taking into
account taxation, interest and reinvestment in assets to continue with the current level of
business. It can be assumed that the annual reinvestment in assets required to continue with
the current level of business is equivalent to the annual amount of depreciation. Over the
past few years, Coeden Co has consistently used 40% of its free cash flow to equity on new
investments while distributing the remaining 60%. The market value of equity calculated on
the basis of the free cash flow to equity model provides a reasonable estimate of the current
market value of Coeden Co.”
Why is the case that in the calculation we do not use $2,600,000*0.6 as the dividends because it states that only 60% of the free cash flows are used as dividends but in the model answer the whole $2,600,000 was used as the dividend.Yes, that’s what I thought at first as well, but after some thought I realized we only exercise the Put option if the underlying asset value decreases, in the case of real options our put option is to abandon the project, and we will only do this if the future flows after the abandonment are expected to be lower hence they are the underlying assets and the put option is the strike price.
I am also studying AFM, so please take this with a grain of salt this is just my understanding of it.yes, sir I have watched your lectures they are very helpful :). I understand the downside of the options to the writer because there is unlimited downside as share price could just become higher and higher and buying shares can hedge this but There is this example in the study hub in “chap no 13 s13.4.2” where a company holds shares of 10 million and the manager is worried that the share price might fall from 22.56 to 20 dollars and one way they said the manager could hedge this is by selling the call options. The delta was 0.7894 so he would have to sell 12.67 million (10m/0.7894) calls and one cent decrease in share price would result in:
suffer a holding loss of $100,000 (0.01 × 10m) on the shares; and
make a holding gain of $100,000 (0.01 × 0.7894 × 12.67m) on the short position in call options.
now the upside potential to the manager from the call option should only be limited to the premuim recived as if the share price reduces the person who bought the call options will not exersize it but in the above example the gain on the holding is proportional to the delta*change in share price. This i do not understand at all as to how all of the poteintial loss is hedged using this.Thank u so much sir! I have learned a lot from u just wanted to say that I am extremely grateful to Open Tuition and to You for providing me with an opportunity to learn without any costs and giving free access of invaluable knowledge to lots of people around the world. We need more people like you in the world 🙂
If your confused about the difference between the two then the spot exchange rate is the exchange rate that is applicable today if we exchange the currency the forward exchange rate is sort of a prediction of what the spot rate will be in the future calculated by the interest rate parity.
If you mean, how will you know which one is the spot rate, and which is the forward rate in the exam, then the question will clearly state which one is which or will ask you to calculate forward rate using the spots rate, but it will clearly state that which is spot rateSir that is exactly what i did in the question i deflated the cash flows by their respective inflation rates and then discounted at the real cost of capital but i got a completely different awnser the reason being in the kit they took the nominal before tax cash flows (so these are inflated by their respective inflation rates) and then deflated the before tax cashflows at the general rate and then deducted the tax effects and discounted at the real cost of capital to get the real NPV.
Also, sir there is another question I just read the article of acca on the Inflation and investment appraisal in the article there were different scenarios they delt with first without taxation they first deflated the nominal contribution by the general rate of inflation and then discounted at the real cost of capital to calculate real NPV
in the next section where taxation was involved, they deflated the after tax cashflows by the general rate of inflation and then discounted it at the real cost of capital.
So, my question is in the Kaplan kit they deflated the before tax cashflows and then deducted tax and added tax saving why they also didn’t do the same thing what was done in the ACCA article to deflate the after-tax cash flows and then discount them at the real cost of capital