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Question/Solution:
NPV @ 10% = 1400
NPV @ 20% = (200)IRR = 10 + 1400/1400+200 x (20-10) = 18.75%
Margin of Safety of 8.75% (18.75-10)
8.75/10 = 87.5%I don’t understand the meaning of the 87.5% at the end. Please advise.
The current estimate of the cost of capital is 10%.
But the estimate could be wrong. However it could be anything up to 18.75% and the decision to accept would still have been the right decision.
Therefore it could increase by up to 87.5% of the current estimate before the decision to accept would have been wrong. This is therefore the margin of safety.
Have you watched my free lectures on this? The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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