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Hi,
Could you kindly explain the rational for using the ungeared cost of equity in APV calculations? Why not WACC or the geared cost of equity? Is it because we are calculating the debt impact separately?
Thank you
Yes 🙂
Using the ungeared cost of equity is ‘measuring’ how good the project is, completely ignoring the effect of using any debt finance.
Then we are calculating separately the benefit of using the debt.
(Discounting the project at the WACC takes account of both effects at the same time, but the problem is that this assumes that the gearing does not change. The APV allows us to deal with changes in the gearing.)
Sir when we have project completely financed from a debt (that can be subsidized loan) while calculating P.V OF TAX SAVINGS ON INTEREST PAYMENTS we always do include the issue cost of debt in the principle amount in calculation for financing effects whether issue cost of debt is tax allowable or not? like in question neptune 800+issue cost 16.32 =816.32 is used for calculating tax savings while in dec 2010 question FUBUKI CO kaplan answers have done calculation on 14488 which includes investment of 14000 and 488 of working capital.
As to whether we include the issue cost of the debt in the principle amount is nothing to do with whether or not the issue costs are tax allowable. It depends whether the issue costs are being paid out the debt raised (in which case we need to raise more than we actually need for the project, and will therefore pay more interest) or whether the issue costs are being paid out of retained earnings (in which case we will only need to raise the amount needed for the project).
and what if sir nothing mentioned how issue cost is being financed and debt is the only finance for project then how r we suppose to treat that?
Then you have to make an assumption.
At the level of P4 do not always expect there to be one correct answer – often you will need to make an assumption, and as long as you state the assumption and it is sensible then you will get full marks.DEAR SIR,
in estimating spot rates in any NPV question whether we are to use mid market price and then apply it to PPP formulae or the one relevant to particular cashflow will be used as I have seen both of them have been used in some past question giving very different results at the end.In an NPV question, where you need to forecast exchange rates in order to convert the cash flows of a foreign project into the home currency,then you would use the rate applicable to either the receipt or the payment (depending which it is) in the PPP formula.
However, I do not think that there has ever been a question requiring this where you have been given the spread (in which case there is no choice anyway).(PS Please – if you ask a question on a new topic, please start a new topic rather than put it under an existing one, because it confuses other people)
Dear sir in dec 2013 Kaplan mock they have done the following:
Forecasting Future Spot Rates based on PPPT:
The Swiss Subsidiary The US investment(SFr/£1
Spot 2.3140 – 2.3210)
Mid prices 2.3175SFr
The inflation rate in Switzerland is higher than the UK rate,
therefore the currency will depreciate against the pound.
Here they have simply taken the average of the buy and sell rate and slotted it into PPPT formulae to estimate the spot rates every year and used the rates to convert currency in original NPV calculationI cannot comment on the Kaplan mock, because I do not have it.
They are correct about the currency depreciating, but more sensible would have been to use the buy or sell rates (depending on which way they are converting).PS From memory, I think I am correct in saying that in every real exam question where you have needed to forecast exchange rates in order to convert cash flows for an NPV question, you have only ever been given one exchange rate rather than a spread (and I have been teaching this paper for over 30 years). When only one rate is given, then clearly mid-market become irrelevant.
I can only assume that Kaplan invented this question and assuming that you have read it correctly, (which I do not doubt) then I think they are wrong.
Yes, of course 🙂
It is Chapter 12 of our free Lecture Notes and the lectures that go with it (the index of lectures says Chapter 11 – I will have it corrected).
Why do you use the ungeared beta for cost of equity…I dont think the question asks for the calculation to find APV isolating debt finance. Correct me if im wrong.
They have also said the airplane is acquired by debt finance.Thank you.
@roshanlunatik said:
Why do you use the ungeared beta for cost of equity…I dont think the question asks for the calculation to find APV isolating debt finance. Correct me if im wrong.
They have also said the airplane is acquired by debt finance.Thank you.
Sorry, didnt mean to say airplane…i meant the funding of the project.
I have absolutely no idea which question you are referring to!!
If it is a past exam question (or a question in the BPP Revision Kit), then tell me which question.
If the question does ask for the APV, then by definition we calculate the NPV as though entirely equity financed, and then add separately the tax benefit on the debt raised in order to get the APV.
Good afternoon sir, from the p4 June 2013 question on Milma, please help me in determining Ziwa cost of capital.
here is the question:
Mlima co’s closest competitor is ziwa co, a listed company which mines metals worldwide. Mlimaco’s directors are of the opinion that after listing Mlima co’s cost of captial should be based on ziwa co’s ungeared cost of equity. Ziwa co’s cost of captial is estimated at 9.4%, its geared cost of equity is estimated at 16.83% and its pre-tax cost of debt is estimated at 4.76%. these costs are based on a captial structure comprising of 200 million shares, trading at $7 each, and $1700 million 5% irredeemable bonds trading at $105 per $100. both Ziwa and Mlima co pay tax at an annual rate of 25% on their taxable proficts.please help me with the ungeared cost of Equity (Ke) in this question
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