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Hello,
I’m having problems understanding the NPV perpetuity question given in june 2011 exams. I looked at the answer but have no idea how is it done. please help. Here’s the link to the question.https://www.accaglobal.com/content/dam/acca/global/PDF-students/2012/june2011q.pdf
The discount factor for a perpetuity is 1/r where r is the rate of interest.
However, this gives the present value (i.e. the amount now) if the cash flows start at in 1 years time (and then each year for ever).
Here, the cash flows do not start in 1 year but in 5 years time – that is 4 years later than ‘usual’.
So….we need to multiply by 1/r (for the perpetuity) and then by the normal discount factor for 4 years so as to get back to the present value now.
(The reason he has also multiplied by (1-0.3) is to remove tax.)
Thanks John. It really helped! And your lectures are just amazing.Just one more concern here.
We already have year 4 values, and the question also asks us to find values beyond year 4 i.e year 5. Then why are we putting in discount factor for year 4 of 0.636 rather than year 5 discount factor? Just lil’ confused here. Would be grateful if you can answer this bit as well.The reason is this:
If it was year 1 and then in perpetuity then just using 1/r would give you the present value (i.e. the value now, at time 0)
But it is year 5 and then in perpetuity, so it starts 4 years later (5 – 1 = 4) and so instead of 1/r giving you the value at time 0 it would give you the value 4 years later – time 4. That is why we need to discount by another 4 years.
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