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John Moffat.
John Moffat.-
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jemma242
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Hi
I am so confused with how in a) the after-tax weighted average cost of capital has been calculated, is there a formula for this? I can do the cash flows but i cannot understand the way in which cost of capital has been calculated.Could you also tell me whether the answer is wrong on the opentuition answers even doing the maths on the paperwork the numbers do not add up correctly!!!
I am also confused with b) the way the internal rate of return has been calculated, is there a formula for this?
I am struggling to understand the opentuition questions however i have gone through the Lectures both revision and tuition but feel lost with the questions!!!!
John Moffat
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If you look at the formula sheet then you will see that there is a formula for the weighted average cost of capital.
However you really should not need to use the formula.
The pre-tax cost of debt is 8.6% and so with a tax rate of 30% then the after-tax cost is 8.6% x 0.7.
The cost of equity is 11%.
So the WACC is the weighted average of the two, weighting by the market values which is given in the question as 80% and 20%.
(You say that you have been through the lectures, but have you watched the cost of capital lectures?)The final answer in the notes is correct, but there are two typing errors which I will have corrected immediately.
One is on the ‘taxable cash flow’ line: the 200 should be under year 1, and the others should all be moved forward one year.
The other error I think should be obvious, but the discount factors for year 2 onwards should have 0. in front of each of them.With regard to the IRR, if you want a formula then you can find one in your Study Text, but there is no formula given in the exam (and all the formula does is write in symbols that I have done anyway). We already know the NPV at 10% from part (a) and so to calculate the IRR you guess at a second interest rate (I have used 20% but you could use any rate), calculate the NPV at this rate, and then approximate between the two.
I really do suggest that you watch the lecture again on IRR (and if necessary watch the lecture on Paper F2 for this also, because it is revision from F2). Once you have got the idea it is very easy indeed and is quite commonly asked as part of a question in the exam.jemma242
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Arhh I see I will re do the question! Yes I think i may re look at the notes for WACC as it threw me off course! I think more practice questions will also help me with this!!!
Sorry for the confusion, I realised after I wrote this I know IRR I think it is the answers that confused me but once i looked over my opentuition notes i managed to do it the way i knew best!! think i need to look at the notes before panicing and looking at the answers as it confuses me more!!!
I would just like to say thank you for getting back to me and all the hard work you put into it 🙂
John Moffat
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You are welcome 🙂
jemma242
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