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Sir, in the question,
1) while calculating the ungeared cost of equity, why are we not considering the post tax cost of debt?2) not a doubt, just a clarification- since over herr, the co wants to redeem all of its debt, we are computing the value of the firm using the ungeared cost of equity (kei). But if thr company had intended on retaining the debt, then we would havr regeared the kei to find ke, and then compute WACC to discount the cash flows to find the value of the firm (in the usual manner), right?
Thanks in advance 🙂
1) The examiner confuses a bit with his symbols 🙂
Kd is the return on debt to investors – i.e. pre-tax. (In fact, strictly it should be the risk-free rate which is always pre-tax)2) What you have written is correct
So I should use the return to debt providers (ie, kd without considering tax) in the calculation of kei, right?
Thanks once again sir! 🙂
Sir, why do we use 1/(0.11-0.035) x 0.659 to calculate the discount factor for free cash flow after 4th year?
Thanks.
(47.6 x 1.035) / (0.11 – 0.035) is to discount the inflating perpetuity. (It is the dividend valuation formula, but it can be used for any inflating perpetuity.) The inflation is 3.5% and the cost of capital is 11%.
However, because the perpetuity starts 4 years late, we then need to discount by 4 years at 11% to get the present value (which is what the 0.659 is, the 4 year discount factor at 11%)
Hi Sir, the discount factor for year 6 to year 15 can i calculate using annuity factor for 15years @11% – annuity factor for 5years @11%?
the answer provided is use 10 year annuity discounted for five years = 5.889 × 0.593, which i don’t really understand.
Thanks.
Yes you can – do it whichever way you find the most obvious for you.
(The answer is usually a very tiny bit different using the two ways, but that is because the discount factors in the tables are rounded to 3 decimal places. That makes no difference in the exam – you still get full marks 🙂 )
Hi John, I have some queries regarding to this question – Re calculating the value without undertaking the project.
Why is there no adjustment to tax allowable depreciation? As this affects the tax calculation. Thanks
It is because the question says that “it can be assumed that the current tax-allowable depreciation is equivalent to the amount of investment needed to maintain the current level of operations”.
The operating profit is already after depreciation, and so the tax figure is correct. The depreciation does not need adding back because although it is not a cash flow, there is an equal cash outflow for new investment.
It is something that the current examiner does very often.Hello John,
In FCFe we deduct interest while calculating the free cash flows.
In FCF we do not deduct interest while calculating the free cash flows.
But in Mlima Co, we are using ungeared Ke. Doesn’t that mean we are doing the FCFe ? The requirement says to use the FCF methodology and the cost of capital calculated in part (i). And the latter is Ke ungeared.
Please clarify.
Using the ungeared Ke does not at all mean we are looking at the free cash flow to equity!!
It is because we are using the Adjusted Present Value approach. Part (a) (i) is asking why we are using this approach, and Part (a) (ii) specifically asks you to use free cash flow (not free cash flow to equity) and to discount at the ungeared cost of equity – again an APV approach.
(Even if we were using free cash flows to equity, we would not discount at the ungeared cost of equity – we would discount at the actual cost of equity!!!!)
Have you watched my free lectures on APV?
Ok got it.. that term for ungeared Ke got me confused.
Hence we use that ungeared Ke in view to find the project’s base case NPV (without taking any debt into consideration).
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