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a lot of doubt !!
1))why the Revised/forecast retained earnings figures(11801) afrer selling off the EV club does not account for the revised forecast profit? And only take into account of profit on sale of EV clubs as the adjusted profit have increase from 1135 to 1331?
2)other info adj 3 they have given us the market value of equity and also told us that there is a slight increase due to the sale so shouldn’t we adjust the statement of financial position for the same?
3)same goes for debt they have given us the market value of debt in other info adj 4 so shouldn’t we adjust the statement of financial positions?
4) answer does not account of the lower interest cost as the pre-tax
cost of debt currently 9% and assumed to fall to 8% when 10% loan notes are redeemed it only account for the decreased interest rate in WACC calculations but it does not account for it in the statement of profit and loss why is that so?1. The question says that the CEO wants to know the impact on the SOFP immediately after the sale, not the impact in 1 years time.
2. The SOFP never shows the MV of equity or of debt. This is financial accounting 🙂
3. Again, this is financial accounting, in the financial accounts we always show the actual interest being paid.
Good day sir, i have few doubts sir on this question:
1) The reason why we didnt include interest saved, return on investment, savings from other loan… is all because question wanted immediate impact. However if they wanted after 1 year impact then i will need to include all profit after tax impact just like Ennea Co question?
2) Usually we do need to include the other loan savings too right sir (9%-8%), however since immediate impact so no need to include that as well. It means if they said its immediate impact only the profit from disposal of EV club only need to be take into consideration.
3) May i know why loan note savings were done based on the coupon rate(10%)? Since the market value was given so i can find the rate of return by ($10/$96) so i will get 10.42%
What you have written for (1) and (2) is correct.
For (3) the actual interest paid on the loan notes is always the nominal/par value multiplied by the coupon rate. It does not depend on the required return (which is what determines the market value).
in the answer for part b) of this problem: eview co (sep/dec 2017) states that: “The lower WACC will be brought about by a fall in the cost of equity as well as the fall in the cost of debt”. But in this problem, the sale of ev clubs will make Ve/(Ve+Vd) higher and Vd/(Vd+Ve) lower than before, and the cost of equity is more expensive than the cost of debt. So why WACC will be lower than before in this problem?
It is a fact that the WACC is lower at 9.93% as against the current 12%.
The cost of equity will always be higher than the cost of debt.
Although the weightings in arriving at the WACC have changed to as to attach more significance to the cost of equity, as you point out, we know that the cost of debt is lower. In addition we would expect the cost of equity to be lower (per Modigliani and Miller, given that the level of gearing is lower).
Usually lower gearing will result in a higher WACC, but in this case the fact that the cost of equity and the cost of debt both are lower is the reason that the WACC has ended up being lower.
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