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Hi sir, for APV questions, there often are issue cost for the debt raised.
1) Do we include the issue cost in the tax shield benefits as well as benefits/loss of tax shield of subsidized loans calculation?
2) Say, risk-free rate is 5%, normal cost of borrowing is 10%, govt provide a loan at a subsidized rate of 4%, is the loan benefit (10% – 4% = 6%) or (5% – 4% = 1%)?
Thank you in advance.
1. The issue costs are not a tax benefit, but we do list them after the base case NPV along with the tax benefits
2. The loan benefit is 10 – 4 = 6%
Thanks sir. For 1st question, I meant if we need to include the issue cost as part of the tax benefits calculation.
For e.g. Company needs to borrow 10mil, issue cost is 1% of gross investment raised. Therefore issue cost = 101k. When calculating the tax benefits (say tax is 20%), is it 20% of 10.101 mil or just 10mil?
Thank you.
It depends on the wording of the question as to whether the amount raised has to include the issue costs (in which case in your example, the tax benefits would be on 10.101M) or whether the issue costs are paid out of existing cash (in which case only 10M would be raised and the tax benefit would be on 10M).
If it is not clear which in the question (and it is not always clear), then (as always) state your assumption and you will ge the marks.
I see. So if i assume that the issue costs are paid out of existing cash, the shortfall of the amount needed to be raised to finance the investment will be assumed to be taken out from the cash reserves of the company, since the actual amount raised – issue cost will be lesser than the amount required?
Whatever happens they will need to raise the amount needed for the project itself. It is just that with regard to the issue costs they either need to raise a bit more than is needed for the project to cover the issue costs, or alternatively they just raise what is needed for the project and pay the issue costs out of existing cash.
Again, unless the question makes it clear which of the two is happening, then make an assumption and state your assumption 🙂
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