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Hey John,
When calculating WACC for NPV they have used expected gearing after investment. (ve= 0.6 vd=0.4)But when calculating Beta asset for ungeared cost of equity for the purpose of base case NPV they have used the amount of investment for the value of equity and debt. (ve=vd=2700 or 0.5)
My question is which value of equity and debt to be used in WACC and in Beta asset for ungeared cost of equity.
When calculating the WACC for the NPV calculation we should use the actual gearing that will exist (i.e. 60% / 40%).
However, when using the APV approach we should use the actual gearing that will existing in the project itself, which is 50%/50% per note (ii) of the question.
(This is an old question – the examiner has changed twice since then, and the current examiner doesn’t appear to play ‘tricks’ like this.)
“However, when using the APV approach we should use the actual gearing that will existing in the project itself”
I saw a question of APV where the project will be financed entirely by convertible debentures. So as per the above logic, the value of equity will be 0 isn’t it ? ?
But they have used the existing debt n equity .Not at all.
With APV you always discount at whatever the cost of equity would be if there was no gearing.
What you asked before was what gearing to use in the asset beta formula in order to be able to find the relevant beta and therefore the relevant cost of equity.
I do suggest that you watch my free lectures on this.
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