Cost of capital — OpenTuition Forums

OOgoegbunam12y ago

Please I need a help in calculation of cost of capital. In one of bpp past questions (Patronic) . As per the question, On August 20X7 Patronic Purchased 18 million of a total of 24 million equity share in Sardonic, The acquisition was through a share exchange of two share in Patronic for every three in Sardonic. Both companies have shares with a par value of $1 each. The market price of Patronic's share at 1 August 20x7 was $5.75 per a share. Patronic will pay in cash on 31 July 20X9 (two years after acquisition) $2.42 per acquired share of Sardonic. Partronic'c cost of capital is 10% per annum. The reserve of Sardonic on 1 April 20X7 were $69 million." My question is this: why is the cost of capital calculated as 18m x $2.42x1/1.21 = 36,000. Instead of 18m x 2.42 x1/1.1= 39600? Thanks, Ogo

MikeLittleTutor12y ago#1

Because you need to discount the 18 million for TWO years, not just one

OOgoegbunam12y ago#2

Thanks Mike, could you please explain how they arrived at 1/1.21, because from my understanding, 10% x 2 years shld be 0.20, plus 1 =1/1.20.

SSangria912y ago#3

@Ogoegbunam Use discount factor 1/denominator, where denominator = (1+r) raised to the power of n. (r - rate, n - number of periods) You'll have: 1/(1+0.1) raised to the power of 2 = 1/1.21

OOgoegbunam12y ago#4

Sangria9, A lot of thanks for that clarification. I really appreciate it....Big, Big hugs.