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Sir can u please tell me why is the tax credit/benefit on depreciation not included.
ThanksSir in the same question one thing more,I know if project is all equity finance then the equity beta equals to the asset beta.But this question mention that the project will be entirely financed by debt then also they have used asset beta while calculating discount rate,then does it mean if the project is entirely financed either by equity or debt asset beta and equity beta become same,please clarify i might be missing some vital point. Thanks
Look at workings (1) of the examiners answer. In calculating the tax, capital allowances have been subtracted from the cash flow to get the taxable profit.
The only reason that equity betas are higher than asset betas is because of the extra risk to shareholders due to gearing. If there is no gearing, then there is no extra risk, and the equity beta and asset beta are the same.
Sir but there is gearing as equity beta is 1.5 and asset beta is 1.25 so isn’t it correct that they should use 1.5 for calculating discount rate. Thanks
But you are asked for the APV, so as always for APV you discount using the cost of equity as though it was all equity financed. All equity finance means as though there was no gearing.
Sir but in second last paragraph it says the project will be entirely financed by debt.
So should i assume it does not matter how its financed if Apv is there we will always use asset beta.Please clarify.
ThanksYou will always use the asset beta to determine the discount rate because this gives the cost of equity if it were all equity financed.
With APV we always discount the project as though it were all equity financed (however much debt is used) and then we add on separately the benefit of the tax child on the debt raised.
Reference to this Burung co
In solution they wrote Interest expenses is irrelevant. My question is why?
Is it a generalized concept to calculate the APV?The whole purpose of discounting is to account for the cost of money. Usually we discount at the WACC which includes the interest cost of debt borrowing, so we do not include the interest as a cash flow because it would then be accounting for it twice.
You asked this in relation to a question on APV, and with APV we discount as though it is all equity financed and then separately deal with the tax benefit of the interest, because according to Modigliani and Miller the only difference of using debt finance is the tax saving on the interest.
All of this is explained in my free lectures.
Sir, why have they deducted capital allowance from the profit to calculate the taxable cash flows ? Isn’t it that we add the capital allowance after finding the tax on taxable profit?
Thanks in advanceThere are two alternatives.
You either calculate the tax on the operating cash profits (before subtracting capital allowances) and then bring in the tax saving on the capital allowances
or
You subtract the capital allowances to get the taxable profits, then calculate the tax, then add back the capital allowances because they are not a cash flow.
My F9 lectures on relevant cash flows for DCF will help you (because dealing with capital allowances is revision of F9)
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