- This topic has 3 replies, 2 voices, and was last updated 7 years ago by John Moffat.

- AuthorPosts
- May 26, 2016 at 9:21 pm #317348
Good Evening!

I am doing Q#25 from the latest bpp kit. one complication is that of a subsidy.

we are given 4 rates:

1) 2% risk free rate (treasury bills)

2) the normal cost of debt on which the company usually borrows, which is 150 basis points above the “10-year govt debt yield rate”, which is 2.5%. the company’s usual borrowing rate is therefore 4% (2.5+1.5).

3) the “10-year govt debt yield rate”, which is 2.5%

4) the subsidy rate is 100 basis points below the rate in (3) thus it is 1.5%the 2% treasury bills rate is given in the context of another co, Liftu which has all the data to calculate ungeared Ke.

and there are 2 loans: one is at the subsidized rate and the other at the the usual borrowing rate

first question: in calculating PV of tax shields on these loans, i discounted using the risk free rate of 2% but the answer uses the “10-year govt debt yield rate” of 2.5%.

i thought tax shields are done at risk free rates..can u pls explain.

second question: in calculating the savings on the interest rate he does

savings = debt x (4-1.5) x 80%

(tax rate is given 20%)i dont understand where the 80% is coming from? if it is related to the tax rate.. how is it related??

regards

May 27, 2016 at 7:59 am #317418There are arguments for discounting at either the cost of debt (which here is 4%, not 2.5%) or at the risk free rate, and the examiner accept either (even though obviously they result in a different answer).

The 80% is to calculate the subsidy benefit net of tax at 20%.

May 27, 2016 at 10:29 am #317447thank u sir

May 27, 2016 at 11:10 am #317459You are welcome 🙂

- AuthorPosts

- You must be logged in to reply to this topic.