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Hello Sir,
Please kindly help me with this. I am solving the seal island question from becker revision kit.
In the question, there’s an expected cash inflow of 100 for 30 years beginning at year 4. the cash inflow is to grow annually by 4%. the discount rate is 10%Growing annuity formula given in the question: (1-(1+g/1+i)^n/i-g)(1+g).
In your previous comments on PV of delayed annuities, you have showed us 2 methods; and these are what i had from applying the 2 methods.
Method 1: Calculate annuity factor for 33years (14.6104) then subtract the annuity factor for 3 years (2.6845). this results in 11.9259
Method 2: Take the 30 years annuity factor (14.11) and multiply by the ordinary discount factor for 3 years (1.1^-3). this results to 10.60
the 2 methods resulted in different results, even though the answers should have been the same. please let me know what I got wrong.
The problem is that the first flow is not stated in current prices, but is an actual cash flow. Therefore, using your method 1 is fine, but the answer then needs multiplying by 1.04^-3 to account for the inflation.
11.9259 x (1.04^-3) = 10.60
(Don’t worry too much about this. This was the last exam set by the previous examiner. He did very odd things (which is why he was stopped as examiner) and I would be amazed if the current examiner suddenly produced this formula 🙂
Even if he did do it, then using 11.9259 as the discount factor, although wrong, but only lose you 1 mark.)
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