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Dear John,
Could you please help me with the below question, I would not have a clue what to write if this came up in the exam.
‘Assume that the loan notes have recently been issued specifically to fund the companies expansion programme under which a number of projects are being considered. It has been suggested at a project appraisal meeting that because these projects are to be financed by the loan notes, the cutoff rate for project acceptance should be the after tax interest rate on the loan notes rather than the WACC. Discuss this suggestion.
But I explain this very point in the lecture that go with chapters 18 and 19 (following on from 17).
Are you not watching the lectures (because I really cannot be expected to type them all out here!!).
He is wrong, because increasing the gearing would cause the cost of equity to increase.
Depending on how many marks were given for it, you could then go on to discuss the different theories of gearing (which again are all covered in detail in the lectures).
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