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We can use either the current borrowing rate of the company or the risk free rate for APV calculations. However the APV examiner answer in Burung Co (specimen 2018) says that
when using risk free rate, the reasoning behind the assumption should be given.
What is the reason behind using the risk free rate in APV?
thanks!But I explain this in my lectures on APV!!
It depends whether we assume the tax benefit to be risk free (in which case use Rf) or whether we assume it to have the same risk as the debt interest (in which case use Kd).
do we have to relate the assumption to the scenario, or can we write this down without reference to the scenario.
That is, if I write down that i have assumed the tax benefit from interest payments to be risk free and thus am using the risk free rate of return to discount the effects of financing. Will this suffice, or further explanation has to be given?
(Plus could you mention the lecture number in which i might find the explanation? Because even though i watched the lectures, the syllabus is massive and things are simply slipping out of the mind)
The assumption is not affected by the scenario 🙂
You can use either Kd or Rf in all cases of APV, but you should always state the assumption (as I have written above) – the examiner always makes it clear that using either will get the marks.
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