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I have a little problem with this question.
In the question, it says that “It is planned to finance the investment project with an issue of 8% loan notes, redeemable in ten years’ time. Vyxyn Co has a nominal after-tax weighted average cost of capital of 10%, a real after-tax weighted average cost of capital of 7% and a cost of equity of 11%.”
They list out a bunch of rates which confuses me. Can you explain what these mean and why the answer chooses cost of capital 10% as the rate to calculate the NPV of the whole project?
Please help me.
Thank you in advance.
I will telly what they all mean, but for a full understanding you really need to watch my free lectures on the cost of capital and on investment appraisal with inflation – you cannot expect me to type out all the lectures again here 🙂 ). All of these terms are very relevant in almost every exam.
The 8% loan notes means that the company is paying 8% interest each year on the nominal value, until the repayment in 10 years time.
The weighted average cost of capital is the overall cost of capital for the company (the average of the cost of equity and the cost of debt borrowing).
The nominal cost of capital is the actual weighted average cost of capital, whereas the real cost of capital is the weighted average cost of capital if there was no inflation. (Higher inflation makes the nominal cost of capital higher).
We discount the nominal cash flows (i.e. the actual cash flows including inflation) at the actual or nominal cost of capital.
Again all of this is explained in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.