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I cant unrestand the calculatio of present value of perpetuity in the following question;
year $m
2001 14
2002 18.50
2003 20.75
2004 onwards 30.25
WACC: 17%the answer is;
2001 2002 2003 2004
cash flow 14 18.5 20.75 30.250
perpetutity (1/0.17) 5.882
value at 2003 177.940
discount factor 0.855 0.731 0.624 0.624My question is why 177.940 is titled as “value at 2003” but is given under 2004 onwards.
and we know 177.940 is obtained by discounting the perpetutiy 30.250 by 1/r formula.
but why its again discoutend by year 3’s dsicount rate (i.e. 0.624)?The discount factor 1/r gives the PV of a perpetuity starting in 1 years time.
Here the perpetuity starts 3 years later (at time 4 instead of time 1), and so multiplying by 1/r gives a PV 3 years later as well – at time 3 instead of time 0. We therefore need to discount the answer for 3 years to arrive at the PV at time 0.
If you are still unsure then do watch my free Paper MA lectures on discounting (because this is revision from Paper MA). I do also explain it in my free Paper FM lectures on share valuations (because this is where it is most commonly relevant in the exam).
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well 🙂
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