00:00:00
[Music]
00:00:08
hello and welcome to this
00:00:10
video I'm milind and I'm an expert tutor
00:00:15
for the AFM
00:00:18
examination in this topic explainer
00:00:22
video for
00:00:24
AFM I'm going to cover some important
00:00:27
aspects about the concept of ADD
00:00:29
assisted present
00:00:31
value and provide you with tips on how
00:00:34
to answer the
00:00:36
tasks that uh require you to estimate
00:00:42
the adjusted present value interpret the
00:00:44
result thereof and then advise the
00:00:47
organization uh based on the details
00:00:50
given to you in this
00:00:52
scenario please remember this is not a
00:00:55
detailed teaching radio but only giving
00:00:58
you some of the
00:01:01
tips so before we actually start talking
00:01:04
about the adjusted present value as a
00:01:07
concept let us look at how uh it's it's
00:01:10
included in the AFM
00:01:15
syllabus well it it is included in the
00:01:20
section B of of the AFM syllabus that is
00:01:24
devoted for advanced investment
00:01:28
appraisal as a decisionmaking
00:01:32
area please be careful in understanding
00:01:35
the learning objective over
00:01:38
here it says you're just not supposed to
00:01:42
make calculations but apply the uh
00:01:47
technique to uh appraisal of investment
00:01:53
decisions and and it
00:01:56
entails significant alterations as this
00:01:59
syllabus words uh in the financial
00:02:02
structure of the
00:02:03
organization including FAL uh fiscal
00:02:07
sorry and uh transaction cost
00:02:10
implications
00:02:13
thereof you must
00:02:15
learn to
00:02:18
revise the concepts that are directly
00:02:21
involved in estimation of the adjusted
00:02:24
present
00:02:25
value namely the discounted cash flow
00:02:29
technique
00:02:30
the weighted average cost of capital
00:02:33
calculations the concepts of asset beta
00:02:36
and Equity beta process of UNG gearing
00:02:41
beta the uh mm proposition Modi ganian
00:02:45
maer propositions for ungeared cost of
00:02:48
equity
00:02:50
calculations please remember this area
00:02:54
is quite often tested in the AFM
00:02:57
examination and from that angle it's
00:03:00
really very very
00:03:01
important of course uh there's uh no way
00:03:05
in which I'm trying to spot questions
00:03:08
for
00:03:09
you but but remember uh very good
00:03:13
learning of this could go a long way in
00:03:17
you you passing the AFM
00:03:20
examination you'll definitely need
00:03:22
rigorous practice on this
00:03:25
topic and here carried forward Knowledge
00:03:29
from your your financial management
00:03:31
paper will will definitely help you
00:03:35
concept of beta the process of UNG
00:03:37
gearing the beta the capital asset
00:03:40
pricing
00:03:41
model revise them in in depth no
00:03:45
doubt of course most of the formula will
00:03:48
be available to you in the formula sheet
00:03:50
even at the AFM examination in the CB
00:03:55
environment and for for this topic which
00:03:59
is is on the new technique of adjusted
00:04:03
present value for you you'll find the
00:04:06
learning material in the Acca study
00:04:10
Hub subsection one of the chapter number
00:04:13
six please don't uh forget learning from
00:04:18
that a very very useful uh resource
00:04:23
directly coming to you from Acca you can
00:04:25
access the Acca study Hub of course from
00:04:28
the my ACC
00:04:31
account so the way the adjusted present
00:04:35
value technique uh
00:04:39
Works uh is definitely a part of your
00:04:42
new learning bringing forward of course
00:04:45
your knowledge from the financial
00:04:47
management
00:04:48
paper but what this technique
00:04:53
entails remember the uh APV technique
00:04:59
has emerged because npv has its
00:05:04
limitations The Net Present Value
00:05:07
technique definitely uh you know
00:05:11
ignores financing cash flows if you
00:05:13
remember those calculations of Net
00:05:15
Present Value we take only investing
00:05:18
cash flows related to initial investment
00:05:20
working capital uh the the net
00:05:23
realizable value at the end of project
00:05:26
period uh realization of working Capital
00:05:29
invested and then the operating flows
00:05:32
like Revenue cost taxation Etc but it
00:05:37
does ignore financing cash flows when
00:05:41
when you evaluate the investment
00:05:44
decision but APV technique
00:05:48
actually is uh uh an improvement over
00:05:51
npv in this
00:05:54
sense it it separates the investing and
00:05:58
operating cash flows from financing cash
00:06:01
flows and tries to assess uh the the
00:06:06
effect of both the cash flows on the
00:06:09
value uh generated by the
00:06:13
project so a project May provide
00:06:17
additional
00:06:18
value if it is funded uh by by making a
00:06:22
sort of a choice which is which is very
00:06:25
very relevant and uh you know uh
00:06:30
suitable for the given
00:06:34
scenario generally what we have learned
00:06:36
at
00:06:37
the financial management level uh is
00:06:42
that if npv is negative we tend to you
00:06:47
know uh reject a
00:06:49
project but a project can generate
00:06:54
additional value if it is for example
00:06:58
funded through
00:07:01
debt in short the the technique helps us
00:07:07
determine the value of a geared project
00:07:10
a project that is funded from debt
00:07:13
that's a geared project and this
00:07:16
actually
00:07:18
again is derived logically from the
00:07:22
modiani Miller preposition that value of
00:07:25
a geared firm is equal to value of an
00:07:27
ungeared firm Plus the present value of
00:07:30
tax
00:07:32
Shields somewhere very close to this
00:07:35
assertion uh you know uh APV technique
00:07:39
helps us in appraising the
00:07:42
project so let's let's quickly look at
00:07:46
what calculations are involved and what
00:07:49
are you supposed to
00:07:50
learn while by learning the concept of
00:07:56
AP it it involves calculating the value
00:08:01
first of all as if the new project is
00:08:04
going to be funded entirely out of
00:08:06
equity no debt only out of
00:08:10
equity and then calculate the present
00:08:14
value of the financing side effects that
00:08:20
flow to the entity due to use of
00:08:25
debt use of debt specifically brings to
00:08:28
us the tax
00:08:32
Shields now the value which we
00:08:36
determine
00:08:37
by uh assuming that the project will be
00:08:40
entirely funded from equity and then
00:08:44
calculate the Net Present Value that npv
00:08:48
is termed as base case npv as if the
00:08:52
project is funded by
00:08:54
equity and the side
00:08:56
effects will generally include as I said
00:09:00
one of them is tax shield on the
00:09:02
interest on
00:09:03
De when you issue new capital in terms
00:09:07
of debt to fund a new project there are
00:09:11
issue
00:09:12
costs of of raising the funds so that's
00:09:15
another financing type cash
00:09:18
flow many times if the project new
00:09:21
project that is been contemplated is of
00:09:24
national
00:09:25
importance to a country in which an enti
00:09:30
operates the entity may get uh you know
00:09:34
government
00:09:35
subsidies so getting government
00:09:38
subsidies or getting softer loans may
00:09:42
act as additional benefit because you
00:09:47
make uh you you make a choice of uh New
00:09:51
Capital to be raised from those
00:09:53
resources so two things the calculations
00:09:57
will require one calculation of a base
00:10:00
case npv second the present value of uh
00:10:04
the financing side
00:10:07
effects so the base case npv as I said
00:10:12
is is uh
00:10:15
calculated with respect to consideration
00:10:18
of initial investment working capital
00:10:21
investment realizable value of the
00:10:24
project and the operating cash flows as
00:10:27
I said earlier like revenues costs and
00:10:31
taxes when you determine the cash
00:10:34
flows use your carried forward Knowledge
00:10:37
from the FM
00:10:40
paper but discount them now here is a
00:10:44
catch you normally discount for
00:10:46
calculating npv you normally discount
00:10:49
taking the weighted average cost of
00:10:52
capital or a Project Specific cost of
00:10:54
capital here you discount it using
00:10:57
ungeared cost cost of equity and why we
00:11:01
take ungeared cost because the
00:11:02
assumption is we are going to fund the
00:11:05
entire project out of equity only no
00:11:09
debt so no gearing and therefore
00:11:11
ungeared cost of
00:11:13
equity now ungeared cost of equity you
00:11:17
can calculate in two ways you will need
00:11:19
to learn the the ways in which to
00:11:22
calculate it and uh the the study Hub
00:11:26
resource very very clearly explains it
00:11:29
to the it to you so you can either use
00:11:33
the process of UNG gearing the
00:11:36
beta taking of course the proxy company
00:11:40
uh information and then using that
00:11:42
ungeared beta in capital asset pricing
00:11:45
model formula to calculate ungeared cost
00:11:48
of
00:11:50
equity if relevant information is not
00:11:54
available to you in the
00:11:56
exhibits you can make use of the mod
00:12:01
proposition for which the formula is
00:12:04
available to you in the uh formula
00:12:08
sheet and again it it is based on the
00:12:11
basic idea of mm preposition that uh
00:12:15
value of geared form equals value of
00:12:19
ungeared form plus the tax
00:12:22
effects so using them you make the
00:12:25
estimate of ungeared cost of equity you
00:12:28
use that as a discount factor to find
00:12:32
out the present value of investing and
00:12:35
operating cash flows finally to get your
00:12:38
base case net present
00:12:41
value so this is a logic that you need
00:12:43
to learn please remember many students I
00:12:47
have found uh you know learn
00:12:50
mechanically and that's not going to
00:12:52
help you because the way in which the
00:12:55
data may be provided in exhibits is not
00:12:58
a standard
00:12:59
way of
00:13:01
information it's is for you to you know
00:13:05
read the exhibits very carefully and get
00:13:08
the information interpreted the way it
00:13:10
is required to so that's very very uh
00:13:15
important for you and then when
00:13:18
considering the present value of
00:13:19
financing side
00:13:21
effects what you will need to do is to
00:13:25
consider cash flows that are related to
00:13:29
for example uh the tax shield on using
00:13:32
debt benefit of subsidized loans and the
00:13:35
issue
00:13:37
costs mainly these three
00:13:40
U you know cash flows uh occur so far as
00:13:44
financing side effects is concerned
00:13:46
sometimes you also could uh get a cash
00:13:49
flow that is related to uh increase in
00:13:53
the debt raising capacity of the firm
00:13:56
I'll talk about that a bit later
00:14:00
take these financing cash flows and
00:14:03
discount them now see that's the
00:14:06
difference between the basic npv and uh
00:14:10
the the APV
00:14:11
method in npv we use only one discount
00:14:15
rate in APV we use ungeared cost of
00:14:20
equity as a discount rate for base case
00:14:23
npv and the pre-tax cost of debt or a
00:14:28
risk free rate for uh calculating the
00:14:33
present value of financing side
00:14:36
effects now experts do defer whether
00:14:39
they should go ahead and use pre- tax
00:14:41
cost of date or risk free
00:14:45
rate the AFM examiner has made it very
00:14:49
clear you could use any of the two but
00:14:52
State your assumption very
00:14:55
clearly so uh these two calculations s
00:15:00
of of of Paramount importance for you to
00:15:04
learn very carefully of course just
00:15:08
learning is not going to be sufficient
00:15:10
for you you need to practice a lot of
00:15:12
sums from the past exam
00:15:17
questions now let's see how the process
00:15:20
of un gearing it's it's I'm not going to
00:15:22
of course teach you this but this is
00:15:24
just uh you know uh revising your your
00:15:28
Knowledge from uh the financial
00:15:31
management paper the uh estimation of
00:15:35
asset
00:15:36
beta it is given by you know multiplying
00:15:40
your uh Equity beta with the value of
00:15:43
equity to the total post tax uh you know
00:15:48
value of equity and
00:15:49
debt this information is available to
00:15:53
you from a proxy company Viewpoint you
00:15:56
have to take that calculate the cost of
00:15:59
ungeared beta and input that in the uh
00:16:03
capm formula as
00:16:07
such
00:16:08
secondly way of second way of doing this
00:16:12
calculation is directly using the mm
00:16:16
proposition and that says cost of a
00:16:18
geared Equity ke is given by cost of un
00:16:22
geared Equity plus difference between
00:16:26
the cost of uh uh
00:16:29
ungeared equity and cost of debt
00:16:33
multiplied by the proportion of debt to
00:16:35
equity post tax of course that's why 1
00:16:38
minus
00:16:39
t if you want to make use of this
00:16:42
formula there's a tip for
00:16:44
you it's it's many times the students
00:16:47
ignore this and and ultimately get
00:16:50
calculations wrongly KD in this formula
00:16:55
has to be taken as pre-tax rate now why
00:17:01
the reason this KD here has to be
00:17:04
pre-tax the reason is you're already
00:17:07
multiplying this by 1 minus t so if you
00:17:12
take here the post tax and again
00:17:16
multiply the bracket with 1 minus t you
00:17:19
will be double counting
00:17:20
taxation so this tip please remember
00:17:24
very very
00:17:25
carefully okay now while
00:17:30
understanding the the normal operating
00:17:32
and investing cash flows is easier for
00:17:35
many of the students because they have
00:17:38
done so well in the financial management
00:17:41
paper uh by plotting cash flows
00:17:44
successfully it's the side effect
00:17:47
calculations that are a bit tricky for
00:17:50
you and that's why I'm I'm going to tell
00:17:52
you about these uh uh you know
00:17:57
calculations uh by way of certain tips
00:18:01
if you put it in this way I I strongly
00:18:04
recommend you you definitely will be
00:18:07
able to uh make the calculations
00:18:09
correctly in the
00:18:11
examination so let's first handle the
00:18:14
cash flow that is related to issue
00:18:17
costs when you are contemplating
00:18:20
investing into new project with new
00:18:23
funding
00:18:24
raised either it could be full debt or
00:18:27
it could be a combination of De and
00:18:29
Equity so the funds that will be
00:18:32
available to you will be definitely net
00:18:36
of issue
00:18:37
costs and therefore when you are talking
00:18:40
about the issue cost related uh cash
00:18:43
outflow you need to gross it up and
00:18:46
that's a very very important step that
00:18:49
generally students miss out on and
00:18:52
unnecessarily lose
00:18:55
marks now I've given a small example
00:18:58
here year that if the funds required to
00:19:00
be invested are 4 million and the issue
00:19:04
cost is 4% the cross funds that you will
00:19:08
have to raise would be you know $
00:19:11
4.17
00:19:13
million so that post the issue cost net
00:19:17
4 million will be
00:19:19
available because these are and and this
00:19:22
is second tip very very important don't
00:19:25
miss out on
00:19:26
this because is costs are uh spent
00:19:31
upfront you don't need to calculate the
00:19:34
present value of issue costs many
00:19:37
students apply discount Factor even here
00:19:39
and uh go
00:19:43
wrong based on the
00:19:45
jurisdiction these issue costs either
00:19:47
may be tax allowable or not allowable so
00:19:51
somewhere in the exhibits look for this
00:19:54
information that's why I said the
00:19:56
information may be available to in a
00:19:58
scattered manner so you have to use all
00:20:01
the sufficient care to make sure that
00:20:04
you read it
00:20:05
properly and that to if there are tax
00:20:07
allowable whether the tax is payable in
00:20:11
the same year in which it is incurred or
00:20:13
it's in areas one year in areas two
00:20:16
years in areas
00:20:17
Etc if it is in areas tax amount
00:20:22
related cash flows you have to calculate
00:20:25
the present value so these are final
00:20:29
points which you should keep in mind
00:20:32
when doing the calculation of financing
00:20:34
side
00:20:36
effects I spoke to you about the debt
00:20:39
capacity spare debt
00:20:42
capacity if you're uh doing the project
00:20:47
that's of certain importance for the
00:20:49
fund
00:20:50
providers you know or it's likely to
00:20:54
give very very high level of values
00:20:57
which will increase your your
00:20:59
Equity so your gearing will improve and
00:21:02
that can provide you with some spare
00:21:04
debt capacity
00:21:06
newly although that spare date you could
00:21:10
use in other
00:21:12
projects please remember that's because
00:21:16
of uh this project that you are getting
00:21:19
uh getting that uh extra capacity so you
00:21:22
should attribute it to the value
00:21:25
generated by this
00:21:27
project and the present value of this
00:21:29
spare capacity should be calculated
00:21:32
using the uh formula trick that I have
00:21:35
given it's logical take the increased
00:21:39
debt capacity value multiply it by the
00:21:43
interest
00:21:43
rate the tax rate because you you're
00:21:46
going to get the tax advantage on that
00:21:49
and the annuality factor based on which
00:21:51
the period for which you are raising
00:21:53
this particular date or the life of the
00:21:56
project so so second financing side
00:22:00
effect the third financing side effect
00:22:03
could be related to subsidized
00:22:07
loans two possible effects can arise out
00:22:10
of that one is the tax shield on the
00:22:13
loan amount
00:22:15
itself so if you're getting a soft loan
00:22:20
take that amount of soft loan multiplied
00:22:23
by the soft loan related interest rate
00:22:27
tax rate of course and the annuity
00:22:30
factor and as I said this you could
00:22:33
discount either by taking the risk free
00:22:36
rate of return or uh pre- tax KD cost of
00:22:41
debt write your assumption whatever you
00:22:43
are
00:22:44
doing and second benefit is related to
00:22:47
benefit because you save in the interest
00:22:50
cost because of
00:22:52
subsidized so you take the amount of
00:22:55
soft loan multiplied by the the
00:22:58
difference in the interest rate normal
00:23:00
loan may be available at 8% you get here
00:23:04
at 6% so 2% is the difference in the
00:23:06
rate multiplied by annuity factor and
00:23:10
take this cash flow post
00:23:13
tax because on the on the saving uh uh
00:23:17
you you need to uh reflect the tax
00:23:20
amount uh that you have to deduct net of
00:23:22
tax benefit will be available again
00:23:24
discount rate could be uh risk-free rate
00:23:27
or the pre
00:23:30
tax learn these very well refer to these
00:23:35
calculations while you are actually
00:23:37
solving past exam questions and do a
00:23:40
rigorous practice on this very very
00:23:43
rigorous practice will be
00:23:47
recommended you need to apply this
00:23:50
technique of
00:23:53
APV many times examiner will not
00:23:56
directly tell you to calculate it
00:23:59
but the exhibit May provide you with
00:24:02
some information where they indicate
00:24:05
substantial change would occur in the
00:24:07
capital structure uh post the new
00:24:10
project or they may tell you financing
00:24:13
uh will be from debt so financing side
00:24:16
effects will uh be there so some hints
00:24:20
The Examiner will give you instead of
00:24:22
directly uh telling you that you know
00:24:25
you should calculate a PV examiner must
00:24:29
just say Okay evaluate the financial
00:24:31
suitability of the project Financial
00:24:33
feasibility of the project now generally
00:24:36
you would try and calculate the npv but
00:24:39
if such hints are given you need to tell
00:24:43
the examiner hey because of these
00:24:45
Reasons I'm using the APV technique and
00:24:49
not the general npv
00:24:52
technique
00:24:54
so two calculations which you make
00:24:58
base case npv might be
00:25:01
negative but if you combine the total of
00:25:05
value generated with the value of
00:25:08
financial side effects it may turn to be
00:25:12
positive and that may mean that you
00:25:14
should go ahead and accept the proposal
00:25:17
and therefore interpreting the base case
00:25:20
inpv and interpreting the present value
00:25:24
of side effects is very very crucial for
00:25:27
you very
00:25:30
crucial of course I mean this technique
00:25:33
also suffers from
00:25:35
criticism experts say
00:25:37
that it it ignores the
00:25:40
impact that uh change in the capital
00:25:44
structure is likely to create on the
00:25:48
value of the firm if you take its
00:25:51
existing
00:25:53
operations and this could be tested in a
00:25:56
very small way in in uh terms of a
00:25:59
discussion
00:26:00
question testing your skepticism skills
00:26:03
once more so beware of this critic it's
00:26:06
it's mentioned in the Acca study Hub so
00:26:09
please learn it very
00:26:12
well I'm showing some you know useful
00:26:17
calculations uh for for calculation of
00:26:20
ungeared cost of equity and and this is
00:26:22
the information that is available to us
00:26:26
uh Alpha is a well divers by risk King
00:26:28
uh seeking company it gearing is given
00:26:32
Equity beta is given and pre-tax cost of
00:26:35
date is given a proxy
00:26:38
firm has a certain uh different gearing
00:26:42
ratio different cost of equity and the
00:26:45
corporate their corporate date is
00:26:48
risk-free the tax rate is given and the
00:26:51
risk free rate is also provided with
00:26:55
with of course the market risk premium
00:26:58
now what you need to do I'm I'm going to
00:27:00
show you both ways in which you can
00:27:02
calculate the cost of ungeared equity
00:27:05
first let us uh you know use uh the the
00:27:10
mm equation where cost of un geared will
00:27:14
be determined by considering the proxy
00:27:16
company for which cost of equity geared
00:27:20
Equity is directly given to us so if you
00:27:23
input the numbers in the uh mm equation
00:27:29
you will be able to solve it and and get
00:27:32
the cost of equity
00:27:35
16% another way in which you can
00:27:38
calculate is by process of on gearing
00:27:40
the beta of proxy and using it in capm
00:27:43
Formula you your answer should not be
00:27:45
different but there is one catch in this
00:27:49
which which I'll definitely tell you and
00:27:51
the catch is when you make use of this
00:27:56
formula
00:27:59
ungeared beta should be directly used in
00:28:02
capm don't rear it students generally
00:28:06
make a mistake uh because they are so
00:28:09
well versed with okay first onar then
00:28:12
rear no you want ungeared cost of equity
00:28:16
and and therefore you need to re need
00:28:19
not rear it but directly apply capm you
00:28:22
see the uh Answers by both are same
00:28:27
which is which is of course the uh 16%
00:28:31
cost of ungeared
00:28:33
equity so depending
00:28:36
on your comfort level you could make use
00:28:40
of any of the approaches in calculating
00:28:43
ungeared cost of
00:28:45
equity well
00:28:48
resources ACC study Hub should be your
00:28:51
primary resource apart from that of
00:28:54
course once you learn the
00:28:56
concepts practice rigorously using the
00:29:00
Acca practice platform where a lot of
00:29:03
past exam questions are available to you
00:29:07
but when you uh look at the past
00:29:11
performances of the students do not
00:29:13
ignore examiners observations on how the
00:29:17
students approach the
00:29:19
answers and therefore I'm so far as this
00:29:22
concept is concerned I'm giving some uh
00:29:25
you know uh comments of the
00:29:29
examiner look at look at this comment
00:29:32
which which The Examiner has made
00:29:35
especially some candidates incorrectly
00:29:39
calculating geared cost of equity rather
00:29:41
than ungeared cost of
00:29:44
equity a conceptual error you know we we
00:29:48
can't make this error While others
00:29:51
calculated weighted average cost of
00:29:52
capital that is also
00:29:54
wrong candidates making these errors
00:29:57
need to understand the rational behind
00:30:00
discount rate
00:30:01
used in in Bas case MP rational that's
00:30:05
the conceptual
00:30:07
understanding look at another
00:30:10
comment on the whole candidates who did
00:30:13
not well demonstrated either a lack of
00:30:16
understanding see lack of understanding
00:30:18
means they have not prepared themselves
00:30:21
in the rational behind discount rate for
00:30:23
base case npv or a lack of question
00:30:27
practice both are very very
00:30:30
crucial isolate the effect of one
00:30:33
business activity in asset beta of a
00:30:35
diversified company so these are really
00:30:40
very clear observations made by the
00:30:43
examin never never forget them never
00:30:46
ignore them for for your
00:30:50
preparation so what have we discussed in
00:30:54
this video will help you in
00:30:57
understanding
00:30:58
why APV can be most important technique
00:31:02
to use uh in in appraising uh an
00:31:06
investment
00:31:07
project and and it could either be
00:31:10
tested in a 50 mark question or in
00:31:12
section A or a 25 marker in section
00:31:16
B so that's it from me I wish you all
00:31:20
the very best for Learning and at the
00:31:22
same time I thank you very much for
00:31:24
watching this video
00:31:29
[Music]
![[Martes Técnicos] - ¿Local o Cloud? - Capítulo 2](https://ruhnrawpgxrzdrgaohnf.supabase.co/storage/v1/object/public/images/video/pzNuq6Yl67s/thumbnail.jpg)
