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Hello sir,
In this question I understood the working and everything in the answer, but the only thing that I didn’t understand was, that how did we decide to follow the APV method in this question and not the normal NPV menthod, since nowhere in the question it has been mentioned to follow APV.
It is unusual for a question not to specify when the APV approach is required.
However here, there is little choice because all of the funding for the new project is coming from debt. The only alternative to an APV approach would be to discount at the WACC, but we do not know anything about the gearing of Megaera.
In addition, mention of the debt capacity of the company being equivalent to the actual amount of debt finance raised is another clue because with APV we calculate the tax shield based on the debt capacity.Got your point sir. Thank you 🙂
sir, i further have 2 small queries in the above question only :
1) while calculating the financing side effects in the answer, the issue cost has not been taken net of tax, why is it so?
2) in the question it has been mentioned that feasibility study was commissioned by the directors at a cost of $250,000, but nowhere in the answer have we accounted this figure in our calculations.
thank you in advance for all your help.
Sir, i want to revise my 2) question because i found the answer to it, that the cost of feasibility has been taken as sunk cost, but if i I would’ve included it Base case NPV calculation would i still get marks for it?
With regard to the issue costs, the answer has assumed that they are not tax allowable (and I am surprised that the answer does not state this as one of the assumptions later).
If you assumed that they were tax allowable (and stated your assumption) then you would still get the marks.
With regard to your second question, it is a sunk cost and therefore should not be included. You would not get marks for it if you included it (but you would still obviously get the marks for whatever else you did correctly).
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