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When calculating for the present value of Tax shield and subsidy benefit on a loan does one has to add the issue cost of the loan to the amount of loan.
Eg: Issue cost= $2.4m
Amount of loan= $ 50 m
Normal borrowing rate 10% for 4 yrs
Tax @ 30%Answer:
1. PV of Tax Shield =10%*50m*0.30*(3.170-0.909)2. PV if Tax Shield= 10%*(50m+2.4m)*0.30*(3.170-0.909)
Kaplan used the 2nd formula in their study textbook.
In Kaplan AFM textbook, the issue cost was added to the amount to be raised when calculating the Tax Shield on the loan and the Subsidy Benefit but upon solving the past questions I’ve seen they don’t add the issue cost to the amount of loan when solving for the PV of tax shield and subsidy benefit.
Can someone please help me.It depends on the wording of the question as to whether the issue costs are paid out of the money raised or whether they are paid out of existing funds.
If it is not clear from the question then (as always in Paper AFM) state your assumption and you will still get the marks. (There is rarely only one ‘correct’ answer in AFM because just as in a real life it depends on your assumptions. Always state your assumptions 🙂 )
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