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sir how does a decreasing share price increase a company’s cost of capital?
It increases the cost of equity, which will not automatically increase the cost of capital (because the lower market value means higher gearing and the overall affect on the cost of capital could be for it to increase or decrease.
You can see that it increases the cost of equity by looking at the growth model formula rearranged (we always use it as rearranged when calculating the cost of equity). Po is the denominator in the formula, and if this is lower then the result for the cost of equity will be higher.
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what is the difference between realisable value and residual value in this type of question.
In this type of question (i.e. calculations of the cost of capital) then neither realisable value or residual value are of any relevant at all.
In calculations of NPV’s in an investment appraisal question then they are relevant and both mean the same thing.
Hi,
I have 2 questions related to this topic, please.
1. In example 7, while calculating IRR, why did we divide 6.06 by 18.28 and not 16.28?
2. In WACC, when we multiple with Kd. that Kd (IRR) should not be (1 – T) right?
Regards,
Waqas1. I assume that you mean example 8 and not example 7, in which case there is an error in the lecture (and I must re-record it). It should have been divided by 18.28 and not 16.28 but at least the printed answer in the lecture notes is correct 🙂
2. With irredeemable debt, we cannot multiply Kd by (1-t). For the cost of debt we have to calculate the IRR of the after-tax flows.
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