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Sir, in this question, why are we ignoring the 40% chance of party B winning the elections?
And, in Reflator Inc (dec 05), in order to find the value of each annual prinicpal repayment of the 9% bond, we are using discounting the loan at 9%. Is this because we assume that 9% is the company’s normal borrowing cost? Had we repaid the 8.5% loan in instalments, would we have discounted it at 8.5% to compute the value of each instalment?
Many thanks 🙂
How would you suggest taking the 40% into account?
Apart from mentioning it in the report, the only thing you could do would be to calculate an expected NPV but that would be meaningless – either A wins or B wins – the outcome could never be any sort of average.When repaying in equal instalments it is an annuity, and the present value of the repayments discounted at the interest rate must always be equal to the amount borrowed.
(Please do not ask about different topics in the same post – start a new thread. The reason is that our answers are meant to help everyone.)
Oh, will keep that in mind sir. Sorry for combining two diff topics in a single thread. 🙂
So, if the 8.5% loan had to be repaid in 6 annual installments, then we would have divided the value of the loan by the 6 year annuity factor for 8.56%, is that right? (this would have been the case even if the company’s normal borrowing cost was 9%?)
No – you would have divided by the 6 year annuity factor for 8.5% (not 8.56%). The normal borrowing cost would be irrelevant for this exercise.
Oops, yes! That’s what I intended to type sir. So irrespective of the normal borrowing cost, we would discount the installment at the int rate applicablr to the bond.
Thanks 🙂
Yes (although you are not discounting the instalment – you are dividing the initial amount by the annuity factor to find the amount of the annual payment).
Hi John, In this question a i and ii, how is the taxable profits of X4 to X9-Y3 is calculated?
Let’s say for 20X4, shouldn’t we simply just charge 30% tax on PBT $24? That will give us 7.2 Tax (0.3*24).
Then we calculate PAT i.e. 16. 8 (24-7.5) and in that amount we add back depreciation of $4 and so on.
And one more thing, the question says that working capital will remain constant after the year 20X8.
In the answer the working capital for the year 20X9-Y3 is zero. Shouldn’t the working capital be $3?
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