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Hi,
I’m getting a bit muddled with APV could you please clarify something for me? When I’m calculating my financing effects I’m always forgetting that we do not calculate the PV of the cost of the finance; only the tax shields and finance savings on subsidised loans are included. why do we not include the actual cost of the finance (for example if our loan costs 8% we calculate loan x 8% x T x A/F to get the savings and not 1-T to get the net financing costs)? surely if we discount at the cost of equity alone to get the base NPV this is not factored into the APV? or is this something to do with the finance costs assumed to be risk free?
ThanksAccording to M&M, as you should remember from Paper FM (was F9), if there were no tax then the WACC would remain constant regardless of the level of gearing. So the NPV with gearing would be the same as the NPV if there was no gearing.
With tax, more gearing reduces the WACC and therefore results in a higher NPV, but the only reason for this is because of the tax saving on the interest.
Thank you for the quick reply, it’s really appreciated! That makes complete sense, hopefully that’ll make me remember not to use the net finance costs!
Collette
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