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Dear sir,
As per revision kit question 36 of Kaplan,
It is mentioned that Issue costs are 4% of the gross finance required. It can be assumed that the debt capacity available to the company is equivalent to the actual amount of debt finance raised for the project.
They have only mentioned that 11m+3m are required initially and also working capital 15% of sales revenue i.e., 488 is required. So total is 14488m requirement.
The questions states that Company intends to raise the full amount of funds through debt finance.In solution they have taken issue cost as (4/96)*14448 = 604.
My confusions:
1) How they come to know that this 14448 is net amount as issue cost needs to be calculated on gross amount. The question has not specified anywhere that the amount is net.
2) Similarly the question has mentioned the intention of company is funding the whole amount through debt. Why they have not included the tax relief on issue cost of debt finance as always calculations involving debt must take account of the tax effects?
Thanks for your assistance.
I do not have the Kaplan Revision Kit. I do have all the past exam questions and answers, but you do not say the name of the question.
However since on what you have typed they need to invest 14,488 they will need to raise more from the debt in order to cover the issue costs and so 14,488 is the net amount.
Having said that, very often it is not clear in exam questions whether the issue costs are being paid out of the debt raised or are being paid out of existing cash. In that case make sure that you write down your assumption regarding this. (For most AFM questions there is rarely just one perfectly correct answer because it depends on assumptions (just as in real life 🙂 ) which is why it is so important to state your assumptions. Provided they are sensible assumptions then you will still get all the marks, even if the final answer is different from the examiners answer.
With regard to tax on the issue costs, although I do not know which question you are referring to, most (if not all) exam questions involving this specifically state that the issue costs are not tax allowable. If nothing is mentioned then always assume that they are not tax allowable but in that case do again state your assumption.
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