Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › cost of debt: 2 pairs of disount rates give 2 IRRs (cost of debt)

- This topic has 13 replies, 3 voices, and was last updated 6 years ago by John Moffat.

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- March 6, 2016 at 7:25 am #303734
Hi Mr John

Sorry I have to raise a question again. And this time is the cost of debt. I have gone thru your lecture and have done some past exams and found out that

when I apply 2 discount factors (ex 5&6%), IRR is different to when I choose 2 other ones (ex 6&7%). Do I get mark on exam my IRR (cost of debt) is different to the exam result? And how can I guess the IRR the same with the exam result?

Thank you Sir.March 6, 2016 at 8:58 am #303765I do answer this in the lecture 🙂

Using different ‘guesses’ will give a different IRR because the relationship it not linear.

Unless the question specifically said what ‘guesses’ to use, then you will get full marks for calculating it correctly using your ‘guesses’. (If you are more than about 1% different from the examiners answer then it probably means you have made a mistake in your arithmetic 🙂 )March 6, 2016 at 2:25 pm #303841More than 1%? OMG I usually guess it base on the interest after tax, so I guess IRR is around the interest after tax. Is it right?

March 6, 2016 at 9:14 pm #303908Probably (although not necessarily)

March 7, 2016 at 6:36 am #303932Hi Mr John

I want to ask you the calculation of IRR

IRR = a + [NPVa/(NPVb-NPVa)](b-a)

Doesn’t matter (NPVb-NPVa) is -/+ it is always + when applied in the formular, right? Because in your example 8 of the cost of debt lecture eventhough it is -16.28 when it comes to the IRR calculation it is +16.28

Many thanksMarch 7, 2016 at 7:40 am #303948I never use a formula for calculating the IRR – it is not necessary to (and I think it dangerous – you might forget it in the exam 🙂 )

The IRR is never negative!

In the example you refer to, because the NPV is positive at 10% and negative at 15%, the IRR must be between 10% and 15%.

March 7, 2016 at 1:43 pm #304037Thank you sir

March 7, 2016 at 3:23 pm #304059You are welcome 🙂

May 15, 2016 at 1:01 pm #315151Hi sir,

For the above you stated that if our calcultaed IRR is different by more than 1% from the examiners’ then it means we made an error somewhere.

I did a question in my kaplan exam kit (Q.42,Tinep Co, Dec’14)

The answer – 4%&5% – IRR=4.7%

I used 10%&15% – IRR=2.7%I did the arithmetic calculation over and over again and still got the same answer. Could the difference be acceptable or there is something i am rily missing?

Please help.

Thank you

May 15, 2016 at 1:18 pm #315153Hi Sir,

Sorry i forgot to add to the above.

Also in the same question they asked to calculate the book value WACC. My confusion is why did they include Reserves in the total book value of equity (Ve) used in the WACC formula?

As the question also asked to calculate marekt value WACC and we only used Ordinary shares in the calculation of the market value of quity!Can you explain why?

Thank you.May 15, 2016 at 2:19 pm #315165Question 1:

Although usually it would be unlikely to be more than 1% different, here it is because you have used such extremely different guesses. You would lose marks, because when you discounted at 10% you would have got a negative NPV and therefore the IRR would have to be lower than 10% and you should not have made a second guess higher.

If you had made your second guess at (say) 5% then you would have been closer to the answer and any difference then would have been acceptable.May 15, 2016 at 2:20 pm #315166Question 2:

The total book value of equity is always the share capital plus reserves (that it is the total owing to shareholders at book value).

However if we are using market values (which is what we always do unless specifically told different) then the market value of the shares effectively already includes the reserves (they are the most obvious reason for the market value of a share being higher than the nominal value).

May 18, 2016 at 8:17 am #315568Hi Sir,

Thank you.I understand now.Ive been doing it the wrong way. You are always good help.

May 18, 2016 at 8:45 am #315583You are welcome 🙂

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