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APV dichotomy

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › APV dichotomy

  • This topic has 3 replies, 2 voices, and was last updated 4 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
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    Posts
  • December 24, 2020 at 3:21 am #600777
    Noah098
    Member
    • Topics: 935
    • Replies: 352
    • ☆☆☆☆☆

    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.

    December 24, 2020 at 8:00 am #600788
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    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.

    December 24, 2020 at 1:58 pm #600805
    Noah098
    Member
    • Topics: 935
    • Replies: 352
    • ☆☆☆☆☆

    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.

    December 24, 2020 at 6:11 pm #600824
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    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.

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