2008 june q2b

Q5 a Anothe question,why the written down value is until end of year 6 that is 31.1 instead of 51.84 at year 5? And how to get tax saving 17.63 and its discounted rate?

z score analysis is not longer in the syllabus for P4.

Q5 Tax is payable one year in arrears, and so given the asset is sold at time 5, the tax effect occurs at time 6. The amount being raised is 800/98% = 816.33 The interest is LIBOR + 1.8% = 7.2%, and so is 7.2% x 816.33 = 58.78 So the tax saving on the interest is 58.78 x 0.3 = 17.63 This is discounted at 7.2% (although as I explain in my free lecture, you would also get full marks if you discounted it at the risk free rate instead ).

Thanks Sir.

Sir,i have try it,but the discounted tax saving should be 17.63/1.072=16.45, i can't get 15.87. One more question, why the $50 mil that incurred over previous year no need to take into account where question state that the costs will be charge to project in the first year operatio?

You are quite correct, and the examiner has made a mistake in his answer!! BPP have got it correct in their Revision Kit - the PV of the interest savings at 7.2% should be (in total) $67.06M. For profit purposes, we can charge the 50M anyway we want. However for cash flow purposes, that money has already been spent and does not affect future cash flows.

Sorry, I have another question : In discounting value, when to use nominal rate and when to use real rate?

You use the nominal (actual rate) to discount the nominal (actual) cash flows (i.e. the cash flows as adjusted for inflation). You use the real cost of capital (i.e. ignoring inflation) to discount the real cash flows (i.e. the cash flows at current prices without inflating them). Almost always it is the first approach that is relevant in the exam.