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Dear sir,
For Adjusted Present value,
when we calculate the net investment required, do we have to include other costs such as redundancy costs that is incurred in year 0 (which is NOT working capital &machine cost)?
Thank you
If they are incremental costs then yes – they are included as we always do in NPV calculations.
I think you might be referring to a past exam question (but you do not say which one, and I cannot remember which one), there the examiner did not include them in the cash flows but then explained why in a statement afterwards and stated the effect.
Hi sir, my query is to calculate the transaction cost and amount borrowed which needs to be used to calculate the pv of financing effects.
1.Do we need to include redundancy cost that is incurred in y0 to calculate the amount borrowed?
Because usually amount borrowed we will only include working capital, machine cost & assume transaction cost need to borrow as well.2. Also, how about when calculate the transaction cost? Do we need to include redundancy cost in net investment required so as to gross up to find the pv of transaction cost?
Thanks sir1. I answered in my previous post.
2. No. We do not gross up anything to find the PV of the transaction cost. If the transaction costs are paid out of the money raised (as opposed to being paid out of existing funds), then we gross up to find out how much was raised in order to be able to calculate the PV of the tax saving on the interest payments.
Let’s say example:
Year 0
redundancy cost (5,000)
working capital (50,000)
machine cost (30,000)Total CF in Year 0 (85,000)
transaction cost is 4% of the gross finance required.
discount rate= 10%
interest rate= 8%
tax rate=5%
The transaction cost will be only 80,000/96% x 4%= (3,333)
PV of tax saving on interest
= (80,000/96%) =83,333 x 8%=6,666then use 6,666 and discount back to PV.
Basically, the transaction cost is only based on machine cost & working capital as per the example above?
Am I correct?
Thanks
Probably that will be the case, but again it depends on the wording of the question. In most questions you are told that the money raised is just for the (in this case) purchase of the machine.
What are the different methods to calculate ungeared cost of equity?
In some questions, the beta asset is used as beta equity to directly calculate the cost of equity (revision kit: Q23). Whereas, in other questions, the beta asset is ungeared using (B x MVe/MVe+(MVd*(1-t))) and the formula provided at the end of the workbook.
Which method should I prefer?
There are not two methods!!
The cost of equity is always determined by the equity beta.
If there is no gearing, then the equity beta is equal to the asset beta.
In APV questions we calculated the base case NPV by discounting at the unguarded cost of equity and as written above, if there is no gearing the equity beta is equal to the asset beta.
Have you watched my free lectures on CAPM and on APV?
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