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Hi Mr Moffat.
I searched all previous questions relating to this on open tuition. Many of my queries were resolved. Except the following.
It says Tramont can borrow dollar funds at an interest rate of 5%. Which is lower than the subsided rate of 6 % in gamala currency. Why not deploy cheaper source of finance for the project compared to subsidised loan? Wondering why this aspect was not covered.
Additionally
What is the whole purpose of this statement that company can borrow at 5% . It’s relevance is to derive a discount factor only? For apv relevance .However 3 percent risk free rate, discount factor resulted through is also valid.
Lastly.
Let’s say 5% is 10 % instead. How would this impact the question?
The question specifically says that they have decided to borrow the funds required in Gamala. There are several reasons why they might have decided to do this (the most obvious being that they will not have to repay the loan!!!), but it is not up to you to question it.
The tax benefit can be discounted at either the normal cost of borrowing or at the risk free rate – the examiner allows both.
5% isn’t 10% so your question is irrelevant. However you would discount then at either 10% or 3%.
Thanks for your valuable insight, however just this last bit of query left, purely for understanding purpose even though the question didnt say so.
If all things equal. we could have deployed 5%?
(ignoring the liability being discarded and have to borrow in gamala as the question says )
As I wrote before, you would discount at either 10% or 5% for the same reasons as before. Both would be acceptable in the exam.
Yes, I am clear on discounting to present value aspect chosing either of them,
But additionally I was wondering, could we have taken a loan out in US dollars at 5 percent and funded the foreign investment instead of taking a subsidised loan at 6 percent. Ignoring the additional details in question. For understanding sake only. All things equal
They could have, but it depends on the circumstances and the information given. It is more normal to borrow in the same currency as the investment in order to match the risk as I explain in my lectures.
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