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In qs 1 i have doubt in theoretical part where they have asked for evaluation amd justification..i cannot understand the points given as project alpha expected to yield a small amount in excess to yield expected from project beta …what does it mean by yield of project
And why project beta duration is lower than project alpha and why project beta risk is lower than project alpha..
Moreover..it is assumed that given discount rate reflects the business risk …but in the question we are given cost of capital how does this reflects the business risk …and what reflects business risk as in APV WE uses ke as discount factor ?Yield can mean several things depending on the context. In the examiners answer it is simply referring to the NPV’s and APV’s – they are similar but Alpha’s are a small amount in excess of Beta’s (and so if this were the only thing to be taken into account then Alpha would just be better).
I assume that you are happy with the calculation of the duration for Project Alpha (it is all explained in my lectures). It is 3.04 years and for Project Beta it is given in the question as being 2.43 years.
Therefore it is lower for Beta than it is for Alpha!
The question specifically says that the risk is to be measured by the project duration and so Beta has less risk than Alpha (the lower the duration the lower the risk, in the same way as we use the payback period in earlier exams).The WACC is affected by both the business risk and the level of gearing. However the question does not give the WACC. It says that ‘the cost of capital for appraising the base case net present value of Project Alpha is 10%’. For APV this is the cost of equity if the project were financed entirely by equity and therefore is only affected by the business risk of the project.
One more question concerning Okan:
Examiner, in his answer, calculated the annual tax shield based on net borrowed amt required – 2.1% x Y$ 24,538,000 x 20%.
I would assume the 3% issue costs are to be borrowed and interest accrued on the gross loan amt like this – 2.1% x Y$ 24,538,000/0.97 x 20%.
According to marking scheme, this is one mark, would I earn it?
thank you in advance
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