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John Moffat.
John Moffat.-
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lasid
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Assume that TQV company has a debt of 200m, equity of 800m, Cost of equity of 12pc (where the company is geared), the cost of debt is 12pc. Tax @ 30pc.
The company wants to raise debt of 100m to buy back equity.
So please explain how to calculate the new market value and the cost of equity in this scenario where the company is geared throughout the scenarios.
John Moffat
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As you have typed it, this question could not be asked in Paper FM!
You would need to assume that the 200m and the 800m are the market values (and not the nominal values) and you would also need to assume that the debt was irredeemable.
On those assumptions you would calculate the current equity beta, then ungear it in order to find the asset beta, and then regear it using the new gearing ratio.
You would then be in a position to apply the new cost of equity to the new dividend stream in order to calculate the new MV of equity, and of source the new MV of debt would be obvious. (All of this is explained in my free lectures.)Presumably you have an answer in the same book in which you found the question (otherwise there is no point in attempting questions – you should be using a Revision Kit from one of the ACCA Approved Publishers because they have answers and workings). So ask about whatever it is in the answer that you are not clear about.
lasid
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