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how do you determine which Discount factor to start with

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › how do you determine which Discount factor to start with

  • This topic has 1 reply, 2 voices, and was last updated 11 months ago by John Moffat.
Viewing 2 posts - 1 through 2 (of 2 total)
  • Author
    Posts
  • February 21, 2022 at 7:26 am #649029
    Abdullah
    Participant
    • Topics: 10
    • Replies: 7
    • ☆

    The equity beta of Fence Co is 0.9 and the company has issued 10 million ordinary shares.
    The market value of each ordinary share is $7.50. The company is also financed by 7%
    bonds with a nominal value of $100 per bond, which will be redeemed in seven years’ time
    at nominal value. The bonds have a total nominal value of $14 million. Interest on the
    bonds has just been paid and the current market value of each bond is $107.14.
    Fence Co plans to invest in a project that is different to its existing business operations and
    has identified a company in the same business area as the project, Hex Co. The equity beta
    of Hex Co is 1.2 and the company has an equity market value of $54 million. The market
    value of the debt of Hex Co is $12 million.
    The risk-free rate of return is 4% per year and the average return on the stock market is
    11% per year. Both companies pay corporation tax at a rate of 20% per year.

    Required:
    (a) Calculate the current weighted average cost of capital of Fence Co.

    Discount Factor for IRR is choosen as 5% & 4%.

    My question is, how do you determine which Discount factor to start with ?

    February 21, 2022 at 9:41 am #649049
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51585
    • ☆☆☆☆☆

    As I explain in my free lectures, it does not. matter what ‘two guesses’ you use (although I do explain the way I think about it in the lecture).

    Appreciate however that in Section C questions you do not need to make two guesses anyway because you can use the IRR function on the spreadsheet.

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