- November 30, 2015 at 11:38 am #286386
I wanted to know why didn’t we take the issue cost of loan to be 4% of $14.488m. In its calculation it has been taken as 4/96 of £14.488. I don’t understand why it is grossed up like that.
Also Subsidy benefit has been calculated as ($14.488m x 80% x 0.02 x 75% x 3.588). My question is where did we get the 75% from and why?
Thanks.November 30, 2015 at 12:10 pm #286400
It is because the question says that the issue costs are 4% of the gross finance.
So for every 100 finance, the issue costs will be 4, leaving only 96 for investing.
So if they need 14,488 to invest the issue costs are 4/96 x 14,488
(Although obviously it is good to get it correct, it is a small point and probably only worth 1 mark. I realise it affects other figures later, but you don’t lose marks twice for the same mistake – provided that your working are clear and the marker can see what you are doing 🙂 )
With regard to the 75%, it is to take the benefit of the subsidy less the tax relief that they won’t be getting on the interest that is subsidised. So they get the benefit of the subsidised interest but lose the 25% tax relief on the interest that they are therefore not paying – leaving a net benefit of 75% of it.November 30, 2015 at 4:22 pm #286467
Thank you for explaining those points sir. It is true that I get stuck with little details and am unable to move on. I will try to change that. Thank you for your kind advice :).November 30, 2015 at 4:31 pm #286474
You are welcome.
While you are practicing then obviously try and get clear on everything, but do make sure in the exam then you don’t let yourself waste time on small things.
Nobody is going to get everything correct in the real exam, but the marks are for proving you know what you are trying to do. That is why it is so important to make sure your workings are neat and clear – it you are trying to do it the correct way then you will pass, however many silly little things are wrong 🙂
(and make sure – especially in question 1 – that you state your assumptions in the report if there is ever something you are not sure about. So often different assumptions from those the examiner makes are valid and will therefore get full marks, even though the final answer will be different from his.)November 30, 2015 at 6:20 pm #286465
Thank you for explaining those points. It is true that I get stuck with little problems but I’ll try to avoid that. Thank you for your advice :).November 30, 2015 at 6:33 pm #286516
You are very welcome 🙂December 6, 2015 at 10:53 am #288169xqhoMember
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Do we use risk free rate or company’s cost of debt in getting ungeared cost of equity in M&M proposition 2 formula? As in Fubuki’s case, risk free is used. But when I practice ques on Kaplan mock exam, company’s cost of debt is used instead. Please advice. Thanks.December 6, 2015 at 2:53 pm #288219
One of M&M’s assumptions is that debt is risk free.
However, in practice debt is not risk free and therefore the return on debt is not the same as the risk free rate.
Best in the exam is to use the risk free rate (but if the return on debt is different, then it is worth just mentioning this as a note – i.e. that in fact the debt is not risk free).
(Whatever, Kaplan should not anyway have used the cost of debt – if they were going to use debt then it should be the return to investors (i.e. pre-tax))December 7, 2015 at 5:36 am #288348xqhoMember
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Excellent explanation! Thank you very much 😉December 7, 2015 at 8:07 am #288388
You are welcome 🙂
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