er, from what i remember lah, Keg is cost of equity formula, whereas Vg is the value of the entity formula.

The argument of M&M is that gearing increases the value of the company, as it reduces to average cost of equity, thus higher net present value. That formula, (the 2nd one, is to calculate that the differential between cost of debt and cost of equity, and increase of value of the entity as a result)

Keg on the other hand is merely the calculation of cost of equity geared, (or in short WACC after gearing). Again it argues that the average cost of capital in the firm reduces with higher gearing.

The main difference is what it is looking for.

Keg = cost of equity
Vg = value of the entity.

Both are actually highly similar, and if u substitute Keg into the calculation of the present value of an entity assuming no change in cashflow, what you get should be Vg.

In short.

Vg = NPV of entity discounted at Keg
Vu = NPV of entity discounted at Keu

Reasoning is fairly simple, actually, and if you look at our present economic situation, the key word is of course, leverage.

Gearing allows you to do more based on the same number of equity.
Because gearing is argued as a low-cost method of funding, compared to equity which has cost that increases with performance/risk, banks as a result take up immense leverage. (or gearing)

Say you have an investor giving u RM500, and the investor, demand 4% as returns But let's say u can take a loan at 2% as well..

Suppose ur investment can be up to a max of RM1000 returns at 5%
So, investing at RM500 via equity,, and RM500 via loan.

Retursn = RM50
Equity RM500*4% = Rm20
RM500*2% = RM10

Profit = Rm20 Right?

But, if u increase this to RM800 by loan, 200 by investor

Returns = RM50
Loan RM800*2% = 16
Equity Rm200*4% = RM 8

Net profit = RM26. Just by changing how u are financed to a lower cost of finance, u are technically increasing the value of ur company.

Let's say as a 3rd party discounting perpetually at 3% to value the entity.

RM20/3% = RM666.67
Rm26/3% = RM866.67.

That is teh reasoning behind why they argue a value of a firm increases with gearing.

Again, the present credit crunch is a good lesson why not to believe it, and why M&M is actually a stupid idea. However, M&M is so stupid, that it's useful, because it fails on so many grounds, yet make sense while doing it. It's weakness is what educates ppl

No. You see. WACCg = Keg*E/(E+D) + Kd (1-t)*D/E+D, tehrefore result would be different.

Why I say Vg = NPV discounted @ Keg is because we are looking from the shareholder's perspective of how much the company is worth to them.

WACCg would be a valuation of the company on itself.



For the valuation or cashflow projections of projects involving financing, we need Keg to calculate WACCg, because your goal is to get the NPV of that specific project. Vg on the other hand is a 'broad' formula for the assessment of an entity. Entity =/= project.

You can argue however, that NPV can be derived using V before project and V after the project, however again, that would be far too complicated, so Keg is often the direct way of figuring out the WACCg for the calculation of NPV/APV or Risk-adjusted NPV, whichever you are doing...

The Keu formula is the formula of deriving how much reduction in cost of capital when we take up a debt.

THe keg + kd formula is merely a weighted average method of calculating WACCg. Both achieve the same goal, but different ways of getting there.

Keg formula is used if there's normally no change in gearing, whereas Keu formula is used when there is a change in financing and yet for some weird reason you are not using APV. (which is why i personally rarely use the Keu formula)

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Added on March 19, 2009, 10:37 pm


APV is actually just a term of separating out the financing effects of a project for calculation.. Generally thoough, you can say it is a APV calculation.

Btw mr michael was my lecturer too hahahaha

Hahaha, no problem. Sorry if I somehow gave you a wrong advice though, because I doubt all my points are accurate hahaha.

Hhahaha, don't let it intimidate you, ;p P4 is very interesting.

Erm, I can't say whether it's an APV method. I know it sounds weird, but generally, I don't use that formula, so I don't know in detail how it works when the calculation is actually performed. I've always stuck to using APV instead because I find it more consistent.

APV considers the timing of financing cashflow separate and distinct from operational cashflow. Using the WACCg = Keu formula as a shortcut for APV would not be the same, BECAUSE the timing of financing cashflow is usually different from normal project operation cashflow.

Under some circumstances, using the WACCg formula to account for the financing effects of gearing would be considered logical, however, most of the cases, it is best to stick to APV. Hahaha, so at the end of hte day, you still need to do APV if the financing side of the project is horribly complicated. (ie, strange payment schedules for financing, restrictions etc)

Ie, ultimately, just use the project WACC without the financing for the project operations cashflow, and then calculate financing separately...

I guess it doesn't answer your question, eh?

Anyway, there's a way to test whether what u say makes sense or not. Try to make a rhetorical question, and attempt them using APV, and then also attempt it using the Keu method. If they both give u the same result, then u have ur answer ;p If they don't, then i guess you have to consider it separately...

This post has been edited by ThanatosSwiftfire: Mar 20 2009, 06:05 PM

I was told that F5, whilst computationally easy (and I agree once I saw the questions), i believe the main points, as raised by allornothing, is in the discussions, and for me, establishing a clear idea of what's going on coherently, (aka point at bottom don't contradict point at top)

if you don't fail. Tuition fees will cost you a rough estimate of RM2k * 11 + RM1k * 9 + 60 * 21 * 6 = Rm40k + OBU Rm8k = RM48k. Somewhre there.

+ Living expenses at RM1.5k a month (rental, food and entertainment) * 36 months = RM 48k (i think this is again highly dependant on ur situation)

Total up, RM96k?

Less any SPM straight As u get, assuming CAT u get full scholarship, it'll cost u RM88k?


So for anyone who's coming in, it'll cost between RM40k - RM96k?

Ever heard of the saying that each newer generation is getting smarter?

I personally feel that thing isn't worth the time and money spent, if your english is up to par to begin with. Besides, nobody sounds super formal in the working world anyway...

Hahaha, anyway let's not go into that debate again alright? Just let him have his opinion. Don't you know ppl who have opinions rarely change them, hahaha. Just let him say what he wants lah.

Wow. This war never ends. hahaha.

It's best we don't argue on this, lest us forget that our goal is ultimately to pass ACCA and be a modern indentured servant in the big 4

Another thing, not to offend anyone, blowing your own trumpet and stating your own qualifications is not the right way to show off ;p. Learn a little subtlely when showing off, very important for your future career hahaha.

Alright. V5

ACCA V5

This post has been edited by ThanatosSwiftfire: Apr 4 2009, 05:53 PM