Comments

  1. avatar says

    Again in calculating discount factors, well if you want to calculate the discount factor of year 2 to infinity at a cost of capital of 14%, you take the perpetuity of 7.143 multiplied by the DF of year 2 of 0.769 to get 5.493, correct me of I’m wrong.

    Now when it comes to let’s say FCFE growing at 3% from year 4 to infinity then calculating the DF you take 1/(14%-3%)*DF of year 3, well my question is why not multiplying by the DF of year 4? Please explain to me the logic I’m getting confused.

    • avatar says

      To the same question if there was no growth rate and FCFE remained constant yeah i knw we wouldnt b deducting the growth rate but what would be the discount factor to the same scenario?

      Any assistance would highly be appreciated.

    • Profile photo of John Moffat says

      You are wrong (and I explained this to you a week ago – below)

      For 2 to infinity you take the discount factor for a perpetetuity and multiply by the one year factor because it starts 1 year late (it starts at time 2 instead of time 1).

      For 4 to infinity you take the discount factor for 1 to infinity and multiply by the 3 year discount factor because it starts 3 years late (it starts at time 4 instead of time 1)

      • avatar says

        Thanks a lot sir. Well different books confused me but now i can clearly get the concept.
        I also appreciate your fast response.

  2. avatar says

    What are the different ways of calculating the discount factor of, for example, year 3-15 at a cost of capital of 11%?
    I tried taking the annuity of year 1-15 then subtracted the annuity of year 1-2, is this method acceptable?
    Another method I tried was taking the annuity of year 1-15 then multiplied with the present value discount factor of year 2, correct me if I’m wrong.
    Thank you.

    • Profile photo of John Moffat says

      Either method is acceptable.
      However, you have made a mistake in your second method. If it is 3 to 15, then there are 13 years of flows. Therefore you should take the annuity factor for 13 years and then multiply by the present value factor for 2 years.

      Both methods will give the same answer (apart from rounding, which is irrelevant in the exam).

    • Profile photo of John Moffat says

      You look up 0.7 down the left hand side, and then 0.07 across the top.

      This should give you 0.2794.

      Then you apply the rule at the bottom of the tables.
      Here, because D1 is >0, you add 0.5 to the figure from the tables.
      so N(D1) = 0.5 + 0.2794 = 0.7794

      It is the same procedure for N(D2)

  3. avatar says

    Sir is Business valuation covered in the audio lectures . And if yes , please guide me where to find them . And secondly post acquisition change is share price and the premium calculations , please guide me where to find them in your audio lectures.
    Thank you.

  4. avatar says

    Dear All/Tutor,

    There is this ongoing issue with Fixed Costs, well not really ongoing but how BPP solved the problem below is bit confusing to me.

    BPP Practice and Revision Kit ( Mock Exam 2, Q1). It is an International Investment Appraisal question. One of the information said and i quote

    “Fixed Costs and local variable costs, which for the first year of operation are 12 million pesos and 600 pesos per unit respectively, are expected to increase by the previous year’s rate of inflation”.

    My interpretaion from the above means both costs are to increase ? so fixed costs will increase?

    BUT the answer only uses variable costs and ignored fixed costs.

    Please any explanation why this was the case or should I just state my own assumptions in the exam and work with that. I know.

    Feedback s are highly appreciated. I just need to pass this P4 this time

    Thanks

    • Profile photo of John Moffat says

      I do not have the BPP mock, but the reason will almost certainly be because fixed costs are only relevant if the total fixed costs increase as a result of doing the project. For profit purposes they may well absorb them over different projects, but for DCF we are only interested if the total fixed costs change.

  5. avatar says

    Please forum/Tutor, can someone help me with the correct treatment of tax allowable depreciation.

    In some solutions, it forms part of the cashflows before tax and after the tax is calculated, it is added back to the After tax cashflow.

    However in Some other answers, what is done is this. They calculate the capital allowance and get the tax effect on the allowance calculated and this is added to the cashflows after tax and if it is a balancing charge the effect is a deduction. So which is the correct treatment

    Many Thanks

  6. avatar says

    If the question said that the Fixed Overheads will grow from year one at a rate of 10%. What will be our charges to put into the NPV calculations?

    Will it be:
    i) yr 1= 20
    yr 2= 42
    yr3=66
    yr4=93
    yr5=122

    or will it be incremental changes

    ii) yr1 = 20
    yr2=22
    yr3=24
    yr4=27
    yr5=29

    Thanks.

    • Profile photo of John Moffat says

      If the fixed overheads are 20 in the first year and grow at 10% per year each year, then they will be 22 in the second year, and so on……..your answer (ii).

      I don’t know why you have called them incremental changes at all. There would be no logic whatsoever in your answer (i)
      (Just suppose you personally pay rent of 20 a year, and I tell you it will increase at 10% a year – it will not mean you pay 42 next year!!!!)

      Separately though, do remember that fixed overheads are only relevant at all if they are extra (incremental) fixed overheads as a result of doing the project. If they are going to be payable anyway then they are not relevant.

      • Profile photo of John Moffat says

        It really depends on assumptions, and whether or not you are told the value of the project at the end of the planning period. Sometimes the examiner has treated the value at the end as if they were sale proceeds (and therefore had a balancing charge/allowance), other times it has just been reducing balance for each year of the planning period. On at least one occasion the problem has been avoided by the question giving the after-tax value, which assumed it had dealt with all taxes.

        If it is not made clear then state your assumption and you will get the marks. In P4 there is rarely one correct answer – it depends often on assumptions made (not just with regard to tax).

      • avatar says

        I’m not getting you. I’m asking, if at the end of a project for e.g 6th year, after charging capital allowance that year, if there still remains some balance and no sale proceeds are given, so will we calculate any unrecovered allowance on it by multiplying with the tax rate?

      • Profile photo of John Moffat says

        The way capital allowances work is this:

        Every year it is a writing down allowance of 25% reducing balance except for the final year.
        In the final year, there is no writing down allowance. Instead you subtract any sale proceeds from the written down value and the difference is a balancing allowance or a balancing charge – that is the capital allowance in the final year.

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