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I did watch your video lecture but in Bpp book, page 162, question of perpetuity
they ask
Investing in a project costing 500,000$, Project would yield nothing in year 1, but from year 2 would yield cash inflow of 100,000$ p.a in perpetuity. Cost of capital =14%
Calculate NPVSolution in the book : npv= -500,000 + 100,000/0.14* 1/(1+0.14)^2 = 49,300
but why 100,000/0.14 multiply for DF 1/(1+0.14)^2
in fact, from year 2 would yield cash inflow of 100,000$ p.a in perpetuity means at the end of year 2 the cash profit is 100,000 in perpetuity, so if we discount at rate = 0.14, it will give the present value of the cash flow at the opening of year 2, or at the end of year 1, to find the present value at the opening of year 1,or at the end of year 0, we just multiply for DF 1/(1+0.14), why they using DF for 2 years 1/(1+0.14)
Another problem. When calculate IRR for a project, i see the solution is using the equation IRR= a + (npv a / (npv…..etc), with try to assume 2 different rate of return
if i write Cash out flow = cash inflow in year 1/(1 +r)+….+ cash in flow in year n/(1+r)^n
and said “using the calculator” , it solved out r= a value
Did i get the full mark when answer like that?Another problem: I do the practice question in BBP book, in the calculate cash flow for a project, they include the “Fixed cost” ( i don’t know it’s a direct cost or just a overhead, or both) and “overhead cost” (don’t know it’s fixed cost or variable cost,or both)to the cash outflow even, with no any information to point out that fixed over head cost is incremental cost like” if the project was carried out, it will cause the additional fixed cost or etc….
What i should do in this case?With regard to your first question, it depends on the exact wording in the book.
If the first receipt is in 2 years time, then multiplying by 1/r will give a present value at time 1, so we then discount by 1 more year at 14%.
If on the other hand the first receipt is after year 2 (i.e. at time 3), then multiplying by 1/r will give a present value at time 2, and then we need to discount the answer by 2 years at 14%.
(by the way, in the exam you do not need to do normal discounting using the formula – you can use the tables provided)I never use a formula – if you see what is happening then you do not need a formula (see my free lecture to see what I mean).
However, provided that your final answer is correct you will get the marks. The danger is that if you make one silly mistake and get the wrong answer then you will get no marks.
You really should calculate the NPV’s for two different rates of interest and then estimate the IRR. The marker will be looking for it, and even if you make a silly mistake you would still get most of the marks because it will be clear what you are trying to do.With regard to fixed costs, in every exam question you are always told somewhere whether the fixed costs are additional or just an allocation of existing fixed costs. However, it does often mean reading the whole question very carefully because a tiny change in wording can make a big difference. I am surprised if there is a BPP question where it is not made clear somewhere, but without seeing the question I cannot say more.
The question is 13 Brideford /15 mark page413 ,BPP textbook F9
Birdgeford is considering whether or not to invest in the development of new product. which would have an expected market life of 5 years.
The managing is in favor about the project because its estimated ARR would be over 15%
His estimates for the project are as follow.year 0 1 2 3 4 5
cos of equipment
total invesment in WC
sale
material cost
labour cost
overhead cost
interest
dep’
total cost
profitthe average anual profit is 530000 with corp tax = 35%, the average anual profit after tax is 344500,with initial investment=2200000, it give ARR= 15.7%
As finace director, you have some criticism of the managing director’s estimates. His figure ignore both inflation and capital allowance on the equipment, and u decide to prepare an amended assessment of the project with the following data.
a) selling price and overhead expense will increase with inflation by 5% pa
b)…
c)…….
d) ….
e)…….
(b->e, contain no any information relevant to overhead cost, it for the inflation rate of material and labour cost, the tax allowance dep’, the nominal rate etc….)Then they required NPV, and assess the project?
I check the solution and see they include overhead in cash out flowI do not have BPP books (and this is not a past exam question).
However, they have assumed that the overheads are variable overheads. With that assumption, extra production will mean extra overheads.
In the real exam it is always made clear somewhere whether the overheads are variable or fixed, and if they are fixed then whether they are additional or an allocation of an existing fixed total.
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