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could you please explain me if we are doing WACC approach, I did not receive same answer like APV interest saved calculation ( 19.64+9=28.64)
KE=20%+0.7(20%-5%)(30/70)=24.5% This is Modiglini&Miller Formula.
Even I am using CAPM approach (new beta based on 70% equity and 30% debt)
Ke =5% + 1.95(15-5) =24.5%WACC= 24.5%*70%+5%*(1-0.3)*30%=17.15%+1.05%=18.2%
NPV = (100)+(40*3.113)=24.52
Why I got these difference?
3.113 is 5 yrs annunity factor @18.2%
I assume cost of debt equl to risk free rateThanks
Keymaster
I have no idea where you are getting your figures from for the cost of equity!The risk free rate is 5%, so I don’t know why you are writing Ke = 20% plus anything!!!
You would need to calculate the equity beta using the asset beta formula, and then use this in the basic CAPM formula to calculate the cost of equity,
Oops sorry – I obviously didn’t read your original question carefully enough 🙁
The problem is that the NPV is the gain to shareholders and will increase the market value of the equity which in turn will change the gearing, which in turn would affect the figures in the formulae.
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