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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=$5mx1%=$.05mcase 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%=$0.1188mAssume= debt receipts are net=$5m
interest rate=8%
tax=30%
issue costs=1%
issue costs=5/.99-5=$.051mcase 3=tax shield is calculated on $5.051mx8%x30%=$0.1212m
case 4= tax shield is calculated $5mx8%x30%=$0.12mI 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.
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.
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.
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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