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- This topic has 1 reply, 2 voices, and was last updated 11 years ago by John Moffat.
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- June 1, 2013 at 2:12 pm #128109
i am really confused in part b we have to calculate the PV after four years the formula for perpetuity is 1/r so 2308 *1/12% should be done but in answer its given 2,308,000 x (1 – 0·3)/0·12 = $13,463,000
moreoverThe year zero present value of these cash flows = 13,463,000 x 0·636 = $8,562,468
If one year’s inflation is included:
2,308,000 x 1·03 x (1 – 0·3))/0·12 = $13,867,000
The year zero present value of these cash flows = 13,867,000 x 0·636 = $8,819,000not able to understand this calculation
June 1, 2013 at 5:39 pm #128133The reason for the 1 – 0.3 is that the 2308 is before tax. There is tax at 30%, so after tax the cash flow is 70% (or 0.7) x 2308.
With regard to the second part of your question, the discount factor for a perpetuity is 1/r (as you say).
However this only gives the present value (now) if the flows are from 1 to infinity.Here, the flows are from 4 to infinity. So whereas 1 to infinity gives a present value at time 0, if it starts 3 years later (4 instead of 1) then it gives a present value three years later – at time 3.
So…..we need to discount the answer for a further 3 years – that is where the discount factor of 0.636 comes from.The reason he shows two different answers is because he realised that the wording of the question could be taken two ways – does the inflation continue for another year or not!!
So…..although you would only give one answer, he accepted either of his two answers because he realised it could be read two ways. - AuthorPosts
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