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Sir,
Here discount factor which they have taken for calculating after tax cost of debt is 7% which is given in question as interest rate before tax. But wouldn’t it be more appropriate to take 5% as discount factor i.e 7% x (1-30%)?
Secondly, they have mentioned that It is assumed that the overdraft can be ignored in calculating the WACC, even though it persists from year to year and is a significant source of finance for BKB Co. But we always ignore overdraft in WACC calculation, correct?
The answer has not used 7% as the cost of debt.
It is redeemable debt and therefore the cost of debt is the IRR of the after tax flows, and it has been calculated in the answer as 6.43%.
As I explain in my lectures, it would only be 7% x (1 – 03%) if the debt was irredeemable and if the market value was 100 (because 7% is the coupon rate).You have asked about overdraft before and I have answered you!! We do not always ignore overdraft – it depends whether it is intended to remain or not. As the examiner has written, he as assumed it can be ignored, but that is just an assumption. You would still get the marks if you had brought it in to the calculation of the WACC (but then you would have to make an assumption as to what interest rate to use given that it is variable interest).
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