Spare Debt Capacity

1) We can calculate the APV in any situation, however we only do it when there is a significant change in the gearing. 2) To get the required return if it is all equity financed you may well have to ungear the beta (if you are given the equity beta for a similar company), but that is all. You use the ungueared beta to calculate the NPV if all equity financed, and then add the tax benefit on the debt. 3) It could be, but you would not do that. There would be no point - the reason for calculating the NPV or APV in the first place would be to decide whether or not to invest. Once you have invested then it is irrelevant what happens later.

And what is spare debt capacity?

There is always a practical limit to how much debt a company can raise (depending on factors such as the amount of equity existing and how much debt borrowing currently exists) Spare debt capacity is the extra that they are capable of borrowing (even if they are not borrowing it all at the moment)

Is there a way of calculating spare debt capacity or is it just information you would be given in the exam?

You would have to be told it as part of the question.

Hello. Please, how does spare debt capacity impact computation of the APV?

As a result of investing in a new project and raising some of the finance from new equity, the amount the company is able to borrow increases (even if they do not borrow as much as may be available). If you are told, for example, that the debt capacity increases by $20M then you would calculate the tax shield on the interest on $20M. We assume that even if they are not borrowing now all of the $20M, they will do in the future. However, I am pretty certain that exam questions for the last twenty years have never mentioned this. We have not been told about the debt capacity and have always calculated the tax shield on the debt actually raised.