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Hi
Lectures are great, thank you.
Ridag Co FM specimen cbe.
Before tax cost of capital is used as discount factor. I understand it says in question to ignore taxation. Silly, but it confused me as I thought nominal should have been used to allow for taxation.
For reference, in what other cases is the before tax cost of capital used?
How can I derive the after-tax cost of capital from before tax? kd*(1-T)?
Thanks
We only ignore tax in Project 2 because the question said to ignore tax. It is not because there is any special rule. The examiner only wrote that tax should be ignored because otherwise it would have made it a harder question and he would have had to give more than 6 marks 🙂
Unless a question specifically says to ignore tax (as this part does) or does not give any information about tax (in which case we are forced to ignore it) then we always us the after-tax cost of capital.
kd is the return on debt which is only part of the cost of capital calculation.
If all that is mentioned in the exam is the pre-tax cost of debt, then yes – the post-tax cost of debt needed for calculating the WACC would be kd*(1-T). However would be unusual – normally you are given information about the debt and you calculate the after-tax cost of debt directly in the ways I explain in my lectures.As far as the cost of equity is concerned, tax is irrelevant and pre-tax and post-tax are the same.
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