- This topic has 1 reply, 2 voices, and was last updated 5 years ago by
.
- Posts
Hi Sir, or anyone. Can you help me about this question? My answer was wrong at Year 11. From Year 11 onwards, investment will generate constant cash flow. Therefore, $100k/1.08= $1250k. So I took discount rate (1/1.08)^11. But the scheme answer given shows that the rate they use is (1/1.08)^10. I dont get it why they use rate at year 10, not year 11when constant c/f begins from 11. Please help me.
(a) Calculate the NPV of an investment with the following estimated cash flows, assuming a cost of capital of 8%:
Years Annual cash flow
$
0 (3,000,000)
1 – 4 500,000
5 – 8 400,000
9 – 10 300,000
11 onwards in perpetuity (per year) 100,000We discount a perpetuity by multiplying by 1/r. However this gives a value at time 0 when the first flow is in 1 years time.
Here the first flow is in 11 years time, which is 10 years later than in 1 years time. Therefore multiplying by 1/r gives a value 10 years later as well – at time 10 instead of time 0 – and therefore needs discount for a further 10 years.
- You must be logged in to reply to this topic.