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Hello John,
I have question which you might not have. Its about decommissioning costs in 33 years.
Cost = 600m x 1.04 (growing 33 years) = 2189m
Then it is discounted to PV at 10% = which gives PV of 94.1mNow I have to find by how much this cost should increase to be equal of 122.2m
Answer is that cost must increase by 122.2/0.1571=777.8 before NPV becomes zero.
I do not understand where 0.1571 comes from. Discount rate for 33 years are 0.043 (10%)
Can you help me with this?
Since the 600M is growing at 4% and we are discounting at 10%, there is an effective or real discount rate of 1.1/1.04 -1 = 0.057692
The 33 year discount factor at this rate is (1/1.057692)^33 = 0.1571
please, can you juxtapose and clarify the difference between seal island co and Lignum co.
1) In Seal co, the annuity discount factor was multiplied by the discounted factor for 10% in year 3
2) whereas, in Lignum co, the annuity discount factor was multiplied by the discount factor of 7.65% for year 3, instead of 12% as given in the question.
I don’t know where you are finding Lignum, but it was asked in the December 2012 exam and there was no discounting involved – the question was entirely about foreign currency risk. (If you have found it in a revision kit, then I can only guess that they have added extra bits on themselves!
BPP have added a part (b) in their Revision Kit,where discounting is required. They have discounted at 7.692% throughout because they are discounting the real cash flow at the real cost of capital – the cash flow was given at current prices. With inflation of 4% and a nominal cost of capital of 12%, then the real cost of capital is 7.692%)In Seal Island, the flows have not been given in current prices – they have been given in year 4 prices, and therefore using the annuity factor at the real cost of capital is giving an actual cash flow at time 3 which therefore needs discounting at the actual/nominal cost of capital to get the present value.
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