Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Discount rate to be used – M/J 2017 Q32 (Vyxyn Co)
- This topic has 9 replies, 2 voices, and was last updated 2 years ago by John Moffat.
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- May 11, 2021 at 2:58 am #620267
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?
May 11, 2021 at 8:28 am #620282We 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.
May 11, 2021 at 1:43 pm #620300Thanks 🙂 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
May 11, 2021 at 1:52 pm #620301Oh 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.
May 11, 2021 at 2:49 pm #620307Sorry! 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?
May 11, 2021 at 5:01 pm #620323If 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.
May 11, 2021 at 9:38 pm #620338I 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?
May 12, 2021 at 7:56 am #620366The WACC as I wrote in my first reply.
May 14, 2021 at 12:00 am #620534Thanks
May 14, 2021 at 9:06 am #620559You are welcome 🙂
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