Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › december 2010 , question 2
 This topic has 3 replies, 2 voices, and was last updated 8 years ago by John Moffat.

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November 21, 2013 at 3:47 pm #147217aliisa
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hello sir ,i have a question from the december 2010 p4 paper .. its question 2 part a , ive understood everything its asked and answered quite well , i just have no idea how they come up with a discount factor of 10% , they’re really isnt any explainnation to support the calculation and im too confused .. your help would be really appreciated sir .
thanks .November 21, 2013 at 4:06 pm #147228John MoffatKeymaster Topics: 57
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We need to know what the cost of equity would be for a project of that level of risk, if it was all equity financed.
They have a company in the same business as the project (Haizum) and we know their cost of equity (14%) but the problem is that they are a geared company. We need to know what it would be if there was no gearing.
To get this they have used the M&M formula on the formula sheet – we ungear Haizums cost of equity using Haizums gearing.(Alternatively, you could work out the equity beta for Haizum, then ungear it using Haizums gearing to get the asset beta, and then used this beta to get an ungeared cost of equity. You would get exactly the same result.)
November 21, 2013 at 10:56 pm #147310aliisa Topics: 11
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thanks for the reply reply sir .. but just one more thing .. how did they calculate the tax shield and the subsidy benefit? im really sorry for the questions sir , im having a hard time understanding the marking scheme.. sorry
and thanks alot for your help.November 22, 2013 at 9:09 am #147345John MoffatKeymaster Topics: 57
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The company borrows at 3% above govt debt (which is 4.5%) and so they pay 7.5% interest.
However, 80% of it can come from a subsidised loan which is 2% cheaper at 5.5%.The total they borrow is 14,488 (the amount needed for the project, grossed up for the issue costs).
They tax tax relief on the interest at 25%.
80% of the borrowing has interest of 5.5% and the other 20% has interest at 7.5%With regard to the subsidy, the are getting a 2% saving in interest on 80% of the money. However since we have accounting for the tax benefits separately, we don’t want to include them again, so the net subsidy benefit is only 75% of this.
Both the tax relief and the subsidy benefit occur each year for four years, and so they have of course been discounting using the annuity factor.

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