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Hi
I have been comparing the above two business valuations questions and wanted to understand the difference on the calculation of the PV after 4 years using DVM.
Pursuit: DVM x 1.13^-4
Chikepe: DVM x 0.735
So, Pursuit uses the cost of capital of 13% and Chikepe uses the PV factor on 8%.
My questions:
1. What distinguishes the two?
2. What are the key indicators that determine which method to use?
3. Why is to the power of -4 used?Many thanks in advance.
There is no difference in the two calculations whatsoever. They have just been typed differently by the examiner in his answer – in one case calculating the discount factor using the formula and in the other cases getting the discount factor from the tables. You could have done it either way for both of the questions.
In the case of Pursuit, the dividend valuation formula has been used on the flows that inflate after 4 years and so the result from the formula is the PV in 4 years time which then needs discounting for 4 years at 13%. You should remember from school that 1.13^-4 is the same as 1/(1.13^4) and is the normal discount factor (it is just an easier way for it to be typed). You could instead have got the discount factor from the tables for 4 years at 13%.
In the case of Chikepe, it is exactly the same for the same reasons. They have multiplied by the 4 year discount factor at 8% (although the answer has just used the figure from the tables instead of typing out the formula).
Hi Mr. John. I have a question concerning the specimen exam (question 3 b). It’s about the calculation of the “PV of annual premium in perpetuity”. I want to know why the post-tax premium of 159.3 has been divided by the WACC of 7% and not discounted as usual? My understanding is that we should rather discount at 7% and not divide. I am a bit confused. Thank you.
You have already asked about the same thing, and I have already answered you!!
They have discounted at 7%.
You should remember from Paper MA and Paper FM that the discount factor for a perpetuity is 1/r where r is the interest rate. So to discount at 7% they multiply by 1/0.07 (which is dividing by 0.07 or 7%).
Ok Sir I got it. The other day when I asked that question I couldn’t find your answer that’s why I asked again. Thank you very much.
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