F7 Chapter 9 – pg 147 – 4.12.2 Deferred consideration

The company’s cost of capital, given in the question, is 8%

In your F2, F3 / F5 days you will have learned about the time value of money and the concept of finding the “today” value of an amount to be paid / received in the future.

In the example you give, ask your self this question (it may make it easier for you to understand the concept)

How much would you need to invest today at an interest rate of 8% in order to have available to pay $108 in one year’s time?

If you were to invest $100 today and earn interest at 8% on that investment, then in one year’s time you would have $108.

Now, ask the same question in a different way. If I have to pay $108 in one year’s time, how much should I invest today at the rate of 8%?

The technical way to do it is to multiply the future amount ($108) by the fraction 1/(1+.08)

Thus 108 x 1/1.08 gives us the $100 to invest today.

If you still are not following this, I refer you to John’s lectures in F2, F3 or F5 (probably F5)