Chapter 12 The Impact of Financing

Ggarlyliu14y ago

Dear Tutor,
I have a question regarding example 2 of the course note page 60 (PDF file).
For part (b), i can calculate the tax saving of 0.45M (p.a.) and the maximum saving would be 0.45 x(1/5%)=9M (as infinity). so APV=28.64M.
But if i use WACC method, the geared Ke =24.5% and WACC=18.2%. the NPV is 24.52M.
Would you please advise why the results are different and which part I did wrong?
Thanks a lot!

Ggarlyliu14y ago#1

Oh i suddenly figure out what i missed.
Sld the cash flow for part (b) be as follows:
Year0:(100)
1:40.45
2:40.45
3:40.45
4:40.45
5:40.45
6-infinity:0.45(p.a.)
For Year1-5, discounted by 18.2%(calculated WACC) and also need to add 0.45/(18.2%)?
So total gain for Part(b)=28.4?
Pls advise if i find the correct answer, thanks!
:

John MoffatTutor14y ago#2

The problem is that the value of the equity will increase by the gain from the project. If we raise the money 70% equity, then because of the gain the equity will end up being more than 70%! This is what complicates it :)

Ggarlyliu14y ago#3

OIC, so i'd better always use APV model. Thanks a lot!

John MoffatTutor14y ago#4

You are welcome :)

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