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There is a qs in bpp kit burcelone
I did not understand how they calculate cost of debt for polar co and burcelone…default risk premium is given and risk free rate …are they adding the two ! How and why?
In exam do we have other variations to calculate cost of debt ?
Also in the same qs the formula used for valuation as fcf
/wacc -g …is not given in book …how do we get idea to use these variations in the formulaBook formula : fcf/ r-g
Would you please interpret the above formula …like what it is going to give ??
Thank u for your time
For your first question, the cost of debt for any business will differ depending on the risk attached. The risk free rate applies when there is zero risk, but in practice there is the risk that the company may default (i.e. not be able to repay the debt) and so the cost is higher – the extra over above the risk free rate is the default risk premium.
For your second question, the formula you quote applies to discounting any inflating perpetuity. When we discount free cash flow then it is the WACC that we use – the rest of the formula stays the same.
So for cost of debt they are adding risk free rate + default risk premium to get the cost of debt for both companies ..am I right ? The figures in the answer relate to the two !..I am still confused
Also I did not understand inflating perpetuity.. May b I need to read again and come again
Thank u
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