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Sir,For many APV past year question, the examiner will be included a note for another rate can be used depending on the assumption made.
If the risk-free rate is being chosen to use as the annuity factor, the assumption made will be something like : based on the M & M theory, the company can be borrowed or lend at the risk-free rate?Is it correct?
Thanks.No, that isn’t the assumption (it is obvious in the questions that they are not borrowing at the risk free rate!!!).
I explain in my free lectures that the rate depends on the riskiness of the tax savings. You either assume they are risk free (and therefore discount at the risk free rate), or you assume the carry the same risk as the interest payments (and therefore discount at the return on debt). This applies to all APV questions in the exam – you can always use either rate but you should always explain the assumption.
It’s for tax shield, how about for the PV of the interest saving of the cheaper loan? Assuming the interest saved after-tax are risk-free?
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