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Hi,
While going through Cima lectures on opentution, I saw that when calculating the present value for a subsidized loan in APV calculations, the discount rate used was the risk free rate of return. However in the Kaplan study text, in a question where one project was funded by partly equity, partly a subsidized loan and remaining with a normal loan, the discount rate applied to discount the benefits from both the loans were the interest rate of the normal loan (the higher interest loan).
I need to know how excaclty to identify which discount rate to be used when the project is finance by,
1. Partly a subsidized loan And remaining with a normal loan (as the situation mentioned above)
2. When only a subsidized loan is taken.
Appreciate a quick response!
Thank you.
Were you supplied with the risk free rate in the Kaplan example? Often the normal interest rate is the risk free rate, and has to be taken as that if the risk free rate is not supplied.
I don’t think the answer is clear. As you say the Kaplan text uses the normal interest rate to discount the benefit of the subsidy. However, a similar example in the BPP text uses the risk free rate. Kaplan’s knowledge bank says:
“As all financing cash flows are low risk they are discounted at either:
the Kd or
the risk free rate.”So that doesn’t help!
This article (note 4 at the bottom of the first page) says it’s open to debate, but that tutor suggests using the normal interest rate – but not deinitive:
So, see what’s available in the question and take you pick if forced to.
Sorry not give a more definitive answer, but I don’t think there is one.
Ken, do you mean Kd/risk free rate less the rate of the subsidised loan being the interest on which the shield is calculated?
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