Hi,
In practice, most entities start off with a post-tax discount rate (as they often use WACC as a start or even as a surrogate measure of the discount rate for impairment purposes) and convert that into a pre-tax rate. Furthermore, many academics and valuation professionals recommend using a post-tax discount rate and post-tax cash flows. Practice also differs between regulators with some taking a more relaxed stance when entities use a post-tax discount rate. Here's how one can convert Post-tax to Pre-tax discount rate for VIU calculations.
| Type of capital | |||||||
| Weights | Costs of capitals | Post-WACC | |||||
| 5 year bond 5% | 10000 | 0.20 | 5.1% | 1.0% | |||
| 10 year debentures | 10000 | 0.20 | 4% | 0.8% | |||
| Bank loan | 10000 | 0.20 | 5% | 1.0% | |||
| 10 year preference shares | 10000 | 0.20 | 5% | 1.1% | |||
| Ordinary equity | 10000 | 0.20 | 8% | 8.0% | |||
| Post-tax | WACC | 12% | |||||
| Pre-tax | WACC | 17% | |||||
| Gearing | 80% | ||||||
Pre-tax WACC formula= Gearing*(cost of Bonds + Debentures + Term loan + Preference share capitals) + (1/(1-Corporat tax)) * Ordinary Equity cost of capital * (1-Gearing).
Post-tax WACC is calculated by multiplying the cost of each capital source (debt and equity) by its relevant weight, and then adding the products together to determine the value.
Please post if there is another method below.
Txs
CAclubindia
