APV dichotomy — OpenTuition Forums

NNoah5y ago

sir have a big doubt related to APV debt receipts. Some questions assume that the receipts are Gross while others assume that receipts are net and then continue their calculations. Now my concern is that we may state an assumption and do the rest of the sum but as far as calculation of interest cost and tax shield is concerned we need to be right there, regardless of whether we take receipt as gross or net. And yet again when calculating interest cost there are varied methods. Assume= debt receipts are gross=$5m interest rate=8% tax=30% issue costs=1% issue costs=$5mx1%=$.05m case 1=In few sums issue costs are not deducted from this gross receipt. and tax shield calculate on $5mx8%x30%=$0.12m case 2= while in the others, what has been done is $5mx1%=$0.05m so tax shield = ($5m-$.05m)x8%x30%=$0.1188m Assume= debt receipts are net=$5m interest rate=8% tax=30% issue costs=1% issue costs=5/.99-5=$.051m case 3=tax shield is calculated on $5.051mx8%x30%=$0.1212m case 4= tax shield is calculated $5mx8%x30%=$0.12m I really want to you help me deduce which of all these are right? Case 1 or 2? when assuming receipts are gross. Case 3 or 4? when assuming assuming receipts are net.

John MoffatTutor5y ago#1

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 being paid out of existing cash reserves.

NNoah5y ago#2

sir but my question is not that. I am asking you to assume that company has no internal accruals and is opting for debt finance. In that situation which of the above two cases should be preferred? Case 1 or 2? when assuming receipts are gross. Case 3 or 4? when assuming assuming receipts are net.

John MoffatTutor5y ago#3

I have no idea what you mean by 'internal accruals'. The tax shield is calculated on the amount of debt that is raised. If $5M is needed for the project and the issue costs are paid out of the debt raised, then the debt raised must be $5M/99% and the tax saving is calculated on the interest on this amount. If the issue costs are paid out of existing cash reserves, then the debt raised will just be the $5M and the tax saving is calculated on the interest on this amount.