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Hi,
“It is planned to finance the investment project with an issue of 8% loan notes, redeemable in ten years’ time. Vyxyn Co has a nominal after-tax weighted average cost of capital of 10%, a real after-tax weighted average cost of capital of 7% and a cost of equity of 11%.”
In this question, why can’t we use the 8% loan notes as the discount rate, since it says it is planning to finance the investment project with an issue of 8% loan notes?
Do we always use the WACC to appraise an investment project?
We cannot just use the 8% loan notes because raising more debt finance will increase the gearing and hence the cost of equity will be higher.
That is why we always discount at the WACC.
You really must watch my free lectures because I explain this point in detail in my lectures on the WACC.
Thanks 🙂 I got it
I had watched your lectures about capital structure theories and WACC before I posted this. But I did not relate or link it to the those. Now, you clear my confusion
Oh yea, another question I want to ask
Why do we have cost of equity also (there is no mention about ordinary shares)? I thought only cost of debt (so we discount at this rate), since they only planning to use 8% loan notes to finance the investment project.
Sorry! I just realised it has COST OF EQUITY of 11%!
My question is what if the question did not mention about the cost of equity?
If a questions wants the WACC then you will either be given the cost of equity, or you will be expected to calculate it using either the dividend growth model or CAPM depending on the information given in the question.
I mean what if they said the investment project is financed by 100% debt finance, and the question also provides WACC and the cost of debt.
Which discount rate should we use?
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