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Hi John,
1)
In (b) (ii), they have inflated the sales value by 10%, the project starts in 6 months, so the year 1 of the project, actually is 1.5years from now. Then shouldn’t the sales for year 1 be 15750*110%^1.52)
In calculating they found the issue costs before (1-T), I did (1-T) as usually issue cost on debt is tax deductible. Will I get mark if I state my assumption?3)
In the APV calculation they have taken base case NPV + Issue costs + PV of tax shield + PV of interest saved. But they have not reduced PV of tax shield lost from the subsidized loan which would be (5%-2.1%)*24538*20%*3.546. Why have they left the same?1. I appreciate that the wording of the question, but it does say that the revenues and costs are in 6 months time (and therefore will already incorporate any inflate between now and six months time).
2. In exam questions we usually assume issue costs to not be tax allowable (unless obviously told differently). However given that it was not stated either way in this question you would still get the marks if you had assumed it to be tax allowable.
3. This can be shown in two different ways (which both end up with the same net result). The tax shield can either be calculated on the loan at full interest rate in which case it then needs reducing by the amount lost due to the subsidised loan. Alternatively (as here) the tax shield can be calculated on the loan at the subsidised rate. Again the end result will be the same.
Hi John,
I understood your explanation for my 2nd and 3rd doubt, but I couldn’t understand your answer to the first question. Can you please elaborate on the same?Thanks in advance.
Sorry, what I meant to type was “I appreciate that the wording of the question could be better, but it does say that the revenues and costs are in 6 months time (and therefore will already incorporate any inflate between now and six months time).”
The revenues and costs given in 6 months time are the amounts expected in 6 months time. They are not the amounts expected now but will have inflated in 6 months time. Time 0 is (as usual) the date of the initial investment (which does not have to be ‘now’), and the requirement does actually specify to calculate the NPV in 6 months time (i.e. the date of the investment).
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Hi
I am slightly confused as to why we are including the after tax benefit of the loan subsidy but not the original interest cost itself?
Thanks
JackWe never bring interest into the calculation of the base case NPV because that is calculated as if the project were financed entirely from equity.
The only reason that using debt finance makes any difference is because of the tax benefit gained as a result of using debt. This is as per Modigliani and Miller – if there was no tax then it would be irrelevant how the project was financed.
Have you watched my free lectures on APV where I do explain this?
(Incidentally, we never bring in interest flows when calculating a normal NPV either because then we are discounting at the WACC, and the calculation of the WACC is taking account of the interest paid on debt.)
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