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Hello John,
1. I have problem to understand the answer of increased working capital. I guess the first year 41=1025×4%, but I cannot work out year 2 figure 53 and year 3 56. Can you please help?
2. Duration of the project. the net outflow is 17025, so it will need between 3-4 years to get npv of inflow =17025. total pv of first 3 years=4104+5627+6826=16557, it doesn’t bring pv to zero yet, how could the answer be 2.78 years. I don’t understand why pv times the percentage of total PV, what does that mean?. The examiner’s answer states:”the result indicates it will take 2.78 years to recover HALF the present value”. the question doesn’t ask HALF PV, very confusion?
Thanks.
Helen
1. The initial working capital is 1025 and so an extra 4% is needed at time 1, which is 41.
So the total is then 1066.
At time 2 an extra 5% is needed, so 5% x 1066 = 53
So the total is then 1119
At time 3 and extra 5% is needed, so 5% x 1119 = 56.2. You seem to be confusing the duration with the payback period. Have a read of Chapter 8 of our free lecture notes. The question asked for the duration, and the duration does measure the approximate time to recover half the present value.
Thanks John.
I have read the course notes and listened lecture of Chapter 8. The Macaulay duration is payback period. it calculates the Pv of each year’s cash flow x time period then divide by MV. I understand the concept. However, the chapter 8 doesn’t mention project duration which was asked in this exam. It calculates the percentage of total PV x time period. Frankly, I don’t know what the project duration is? Why do we need to measure the duration of recovering half the PV, what’s the logic behind this calcutaion?
The Macaulay duration is not the payback period. (The payback period is the number of years it takes to get back the initial investment, which is not the same thing).
It is calculated for projects in exactly the same way as it is for the bonds in the example in the lecture notes.
You will get exactly the same answer whether you multiply the PV’s by the years, add them up, and divide by the total PV; or whether you divide by the total PV first, and then multiply by the years and add them up (as the examiner did in his answer).A feature of it is that it gives the time taken to recover approximately half of the present value. This is something that you cannot be expected to prove (which is rather tricky anyway) but you need to be able to state.
Obviously, the shorter it is the better.
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