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Dear John,
I had a question in the exam relating to relevant cash flows. Was so confused!
Investment now was 150,000, installation cost paid now was 56,000. if the asset is sold, it will be in year 2 and Disposal of asset would be 30,000 and giving profit of 1,000. Discount factor 12%
Yr 1 Sales= 100,000, D.Mat 10,000 D.Labour: 20,000 Fixed OHs: 5,000
Yr 2 Sales= 150,000, D.Mat 10,000 D.Labour: 20,000 Fixed OHs: 5,000
Yr 3 Sales= 200,000, D.Mat 10,000 D.Labour: 20,000 Fixed OHs: 5,000What is the relevant cash flow?
I believe I have to deduct all the costs from the sales and then discount it at 12%? Also the investment will be 150,000 + 56,000= 156,000 I believe. I cant remember if fixed overheads were Direct, if it is direct then i have to deduct it from the sales right? If its not direct then I must ignore it? The main thing that i was not sure is whether to use the discount factor to use the time value of money and get the NPV. The question itself confused me by ‘relevant cash flow’
Hope I didn’t confuse you too much 🙂
Thanks for your help as always.
You need to calculate the net cash flow in each year, but subtracting the costs from the revenues. The you discount each year at the rate of 12%.
Fixed overheads are relevant if they are extra fixed overheads to the business.
Thank you so much for the response John! One more clarification I need for this question, If the asset is sold, it will be in year 2 and Disposal of asset would be 30,000 and giving profit of 1,000. So in yr 2 I must subtract all the relevant costs from the revenue of 150,000 and then add the disposal amount of 30,000 then discount it at 12%? Is that right?
Thank you so much for your help.
If it is sold in year 2, then yes – you add the proceeds of 30,000 (the profit itself is not relevant because we only want the cash flows).
I am a bit puzzled why they gave information for 3 years when it is sold in 2 years, but I do not know which question it is you are referring to 🙂
It was in the real exam question which I struggled answering it and got 48% 🙁 They gave me sales figures up to three years. They confused me by saying ‘if the asset is sold, it will be in year 2 and Disposal of asset would be 30,000 and giving profit of 1,000. The word ‘if’ confused me a lot. the question right after it was; What are the incremental cashflows in Year 1 and year 3.
Hope this makes sense 🙂
Dear John,
I have passed my exam 55% today! Thank you so much for your support! 🙂
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