Thank you for your lectures they are very clear and easy to understand.
I however have one small question on example 2 IRR calculation where we deducted -2160 from +6660 the answer should it not be +8820 instead of -8820? Is there anything I have missed
It really doesn’t make any difference whether you put a + or a -. If you understand what is happening (and not just learning a rule) then you will get the correct answer.
I put – simply because it is a fall of 8820 to go from +6620 down to – 2161.
Thank you for the great work, this video played a big role in the success of my exam. With open tuition videos and notes I was able to prepare within the limited time I had. Once again thank you for the explanations and notes
Hi John, I have a question concerning depreciation when calculating cash flows and NPV.
In ACCA F2 exam kit I came over a test in which depreciation was included when calculating cash flows (the explanation in answers was the following: “Depreciation is not a cash flow so needs to be added back to profit to calculate cash flows”).
But F2 text books and comments here state that depreciation is not an actual cash flow so it is not included in the capital appraisal calculation.
How can I differentiate when it should be included and when not? Or maybe there was a mistake in the exam kit?
Please don’t put links to other websites (the link you gave was more relevant to Paper P4 anyway), and please in future ask this sort of question in the Ask the Tutor Forum.
Net present value is always calculated using only the cash flows, as explained in my lecture. Accounting profits are after subtracting depreciation. Depreciation is not a cash flow and therefore it needs to be added to the accounting profit to determine the cash flow. There is certainly not a mistake in the exam kit – this point is fundamental to NPV calculations.
Hi John, I just have one question, how to know with accuracy with table to use? I mean by that how to distinguish this is the annuity table or the present value table that I going to use when it comes for calculations. thanks
Hi John, For NPV, I have a Question. I understand the calc but I just want to have a deep understanding of why. The interest is 10%, but why are we calcing this against receipts and not against the loan/investment figure of 80k? With simple interest we come in with a figure of 6,000 net present value. W/ compound, 7,128. I know these are wrong. I just want to grasp fully, why we deduct from the receipts and not the investment/loan…..It’s been a long day.
You could add interest to the amount borrowed and end up with a terminal value (as I explain in the lecture). However, rather than end up with a value at the end of the project’s life, it is more useful for decision making to have an equivalent value ‘now’ which instead means removing interest from the future cash flows.
Hi John Can you please help, if I have a calculator which calculates NPV and IRR automatically – is it worth using it? Because for IRR I always to get different answer than using the approach discussed in the lecture for about 1 percentage point. Thanks. For now it seems that it can only create problems in the exam.
Thank you! No, it’s a general calculator designed for CFA exam, the only thing it calculates similiar to the answers is just the payback period, unfortunately.
musealk3says
Hi John. There’s a question in the practice exam about Accounting Rate of Return, and I’ve watched both of your Investment Appraisal lectures, but I can’t find ARR in either of them. Is there another lecture I’m not aware of? Thanks for all your help so far. 馃檪
I would like to know if it is possible for IRR to be less than cost of capital and NPV to be positive, or IRR to be greater than cost of capital and NPV to be negative, should we accept the project? Based on which criteria?
If the IRR is less than the cost of capital, then the NPV will be negative and the project should be rejected. If the IRR is more than the cost of capital then the NPV will be positive and the project should be accepted. The reasoning for this is explained within the lectures on IRR.
Good day In the mock exam there is a question to calculate the NPV, however this question includes inflows and outflows in every year. I took the net (Inflow less outflow) p.a and calculated that based on the NPV table in every year. I have done the question several times but my answer is always incorrect (I have NPV of +$53,520) the answer when I review is +$53,610 – This is a small difference and I wonder if the NPV table with only 3 decimals could cause this?
The question is as follows: Initial investment $300,000 Inflow per annum $120,000 Outflow (Incremental cost) per annum $30,000 Scrap value $20,000
The IRR is the rate of interest at which the NPV is zero. It is irrelevant when calculating it what the cost of capital is – the cost of capital may be higher or lower than the IRR.
For the first example, although the NPV has a surplus of $6660, why should we accept the project if we could invest $80 000 at 10% interest p.a. for 4 years which will give a total return of $117 128? Thanks!
But if you invested the returns from the project at 10% per year you would end up with 126,920 which is more! That would be the terminal value, and you cannot compare terminal values with present values. The net terminal value would be 126,920 – 117,128 = 9,792 The net present value is 6,660.
6,660 now is equivalent to 9792 in 4 years time (6,660 x 1.1^4 = 9,751, the difference is simply due to rounding)
20,000 invested for 3 years (year 1 to year 4) grows to 20,000 x 1.1^3 30,000 invested for 2 years grows to 30,000 x 1.1^2 40,000 invested for 1 year grows to 40,000 x 1.1 and a total of 20,000 in 4 years, stays at 20,000
Then add them all together 馃檪
righansays
Hi Sir, Is the figure “15%” a given figure or at random? or I can choose another percentage like 16% 17% 20% etc; How can I get this percentage figure to compare?
I do make it clear in the lecture than you can use any two ‘guesses’ in order to calculate the IRR (unless, obviously, the question specifically tells you which two rates to use).
You use the formula that is given at the top of the formula sheet (depending on whether you want the normal discount factor, or the annuity discount factor). I go through this in the previous lecture.
Thank you for help. One question though..in the test post the chapter I’m not understanding why 8% was used to arrive at the IRR of 18%. I did get 18% but this was done the long way. Please assist
I don’t know what you mean by ‘the long way’- there is only one way of doing it, making two ‘guesses’ and then approximating between them.
Since we had already been asked to calculate the NPV at 12%, we had one value. You could try any rate of interest for the second value – my answer tried 20%. (8% is the difference between 20% and 12%).
morenike1 says
Hi John,
Please I don’t understand how (6660/8820*5%) results to 3.78%. Please help
John Moffat says
Try dividing 6660 by 8820, and then multiply the answer by 5 !!
tejal14 says
Hello Sir,
Thank you for your lectures they are very clear and easy to understand.
I however have one small question on example 2 IRR calculation where we deducted -2160 from +6660 the answer should it not be +8820 instead of -8820? Is there anything I have missed
Thank you
John Moffat says
It really doesn’t make any difference whether you put a + or a -. If you understand what is happening (and not just learning a rule) then you will get the correct answer.
I put – simply because it is a fall of 8820 to go from +6620 down to – 2161.
tejal14 says
Yeah that is true. Thank you very much for the response
John Moffat says
You are welcome 馃檪
loukasierides says
Dear Sir,
using the cross multiplication is very helpful both for understanding but also to save time and learning long formulae. Thank. you very much
jennifer12 says
Hi John,
Thank you for the great work, this video played a big role in the success of my exam. With open tuition videos and notes I was able to prepare within the limited time I had. Once again thank you for the explanations and notes
John Moffat says
Thank you for your comment, and many congratulations on your success 馃檪
elko1212 says
Hi John,
I have a question concerning depreciation when calculating cash flows and NPV.
In ACCA F2 exam kit I came over a test in which depreciation was included when calculating cash flows (the explanation in answers was the following: “Depreciation is not a cash flow so needs to be added back to profit to calculate cash flows”).
But F2 text books and comments here state that depreciation is not an actual cash flow so it is not included in the capital appraisal calculation.
How can I differentiate when it should be included and when not? Or maybe there was a mistake in the exam kit?
Thank you very much!
John Moffat says
Please don’t put links to other websites (the link you gave was more relevant to Paper P4 anyway), and please in future ask this sort of question in the Ask the Tutor Forum.
Net present value is always calculated using only the cash flows, as explained in my lecture. Accounting profits are after subtracting depreciation. Depreciation is not a cash flow and therefore it needs to be added to the accounting profit to determine the cash flow.
There is certainly not a mistake in the exam kit – this point is fundamental to NPV calculations.
Thierry says
Hi John, I just have one question, how to know with accuracy with table to use? I mean by that how to distinguish this is the annuity table or the present value table that I going to use when it comes for calculations. thanks
John Moffat says
But I explain this in the lectures!!
You use the present value table for individual cash flows, and you use the annuity table for equal annual cash flows.
Thierry says
Thanks a lot.
cfin says
Hi John,
For NPV, I have a Question. I understand the calc but I just want to have a deep understanding of why. The interest is 10%, but why are we calcing this against receipts and not against the loan/investment figure of 80k? With simple interest we come in with a figure of 6,000 net present value. W/ compound, 7,128. I know these are wrong. I just want to grasp fully, why we deduct from the receipts and not the investment/loan…..It’s been a long day.
John Moffat says
You could add interest to the amount borrowed and end up with a terminal value (as I explain in the lecture).
However, rather than end up with a value at the end of the project’s life, it is more useful for decision making to have an equivalent value ‘now’ which instead means removing interest from the future cash flows.
cfin says
Thanks John.
pavelpavlovmsc says
Sorry John if a question asks us to round the IRR to the appropriate integer should we always round it downwards? Why if so?
John Moffat says
No – round it to the nearest integer.
pavelpavlovmsc says
Hi John
Can you please help, if I have a calculator which calculates NPV and IRR automatically – is it worth using it? Because for IRR I always to get different answer than using the approach discussed in the lecture for about 1 percentage point. Thanks. For now it seems that it can only create problems in the exam.
John Moffat says
No – don’t use it 馃檪
(And if it displays text as well as numbers then you are not allowed to take it to the exam)
pavelpavlovmsc says
Thank you! No, it’s a general calculator designed for CFA exam, the only thing it calculates similiar to the answers is just the payback period, unfortunately.
musealk3 says
Hi John. There’s a question in the practice exam about Accounting Rate of Return, and I’ve watched both of your Investment Appraisal lectures, but I can’t find ARR in either of them. Is there another lecture I’m not aware of? Thanks for all your help so far. 馃檪
Aidan
John Moffat says
I should really remove it because ARR itself is not in the syllabus.
However it is effectively the same as ROI which is covered as part of divisional performance measurement.
acca0001 says
Hi Sir,
I would like to know if it is possible for IRR to be less than cost of capital and NPV to be positive, or IRR to be greater than cost of capital and NPV to be negative, should we accept the project? Based on which criteria?
Thanks!
John Moffat says
If the IRR is less than the cost of capital, then the NPV will be negative and the project should be rejected.
If the IRR is more than the cost of capital then the NPV will be positive and the project should be accepted.
The reasoning for this is explained within the lectures on IRR.
Walt says
Good day
In the mock exam there is a question to calculate the NPV, however this question includes inflows and outflows in every year. I took the net (Inflow less outflow) p.a and calculated that based on the NPV table in every year.
I have done the question several times but my answer is always incorrect (I have NPV of +$53,520) the answer when I review is +$53,610 – This is a small difference and I wonder if the NPV table with only 3 decimals could cause this?
The question is as follows:
Initial investment $300,000
Inflow per annum $120,000
Outflow (Incremental cost) per annum $30,000
Scrap value $20,000
Please help! 馃檪
John Moffat says
Yes – it will be because of the rounding in the tables. Best is to use the tables that are provided in the exam 馃檪
Walt says
thank you!
John Moffat says
You are welcome 馃檪
sal2222 says
I’m confused on this difference too. I still get that difference even though I am using the tables provided at the beginning of the notes.
zee says
Do I have to worry about annuities and perpetuities in advance/arrears?
zee says
Also I wish to know why there is no impact on IRR when the cost of capital changes? Just came across a MCQ!
John Moffat says
The IRR is the rate of interest at which the NPV is zero. It is irrelevant when calculating it what the cost of capital is – the cost of capital may be higher or lower than the IRR.
John Moffat says
Yes – annuities and perpetuities starting at time 0 instead of time 1, or starting later than time 1, are examined and are covered in the lectures.
acca0001 says
Hi sir,
For the first example, although the NPV has a surplus of $6660, why should we accept the project if we could invest $80 000 at 10% interest p.a. for 4 years which will give a total return of $117 128? Thanks!
John Moffat says
But if you invested the returns from the project at 10% per year you would end up with 126,920 which is more!
That would be the terminal value, and you cannot compare terminal values with present values.
The net terminal value would be 126,920 – 117,128 = 9,792
The net present value is 6,660.
6,660 now is equivalent to 9792 in 4 years time (6,660 x 1.1^4 = 9,751, the difference is simply due to rounding)
acca0001 says
Right…i was not thinking about investing the returns. May I know how you got the terminal value $126 920? Thanks for your prompt reply!
John Moffat says
20,000 invested for 3 years (year 1 to year 4) grows to 20,000 x 1.1^3
30,000 invested for 2 years grows to 30,000 x 1.1^2
40,000 invested for 1 year grows to 40,000 x 1.1
and a total of 20,000 in 4 years, stays at 20,000
Then add them all together 馃檪
righan says
Hi Sir, Is the figure “15%” a given figure or at random? or I can choose another percentage like 16% 17% 20% etc; How can I get this percentage figure to compare?
John Moffat says
I do make it clear in the lecture than you can use any two ‘guesses’ in order to calculate the IRR (unless, obviously, the question specifically tells you which two rates to use).
Sammar says
17400 + 22680 + 26320 + 5720 + 5720 = 77840
80,000 – 77840 = 2160
It gives a positive value not a negative???
John Moffat says
What you have written does give a positive value, but you have written it wrong!!
The 80,000 is an outflow (which is why it has brackets round it). The other flows are all inflows. So there is a net outflow.
Sammar says
Oh yeah, sorry about that.
crisa0702 says
How do I calculate the discount factor for a 12.5% discount rate? Thank you
John Moffat says
You use the formula that is given at the top of the formula sheet (depending on whether you want the normal discount factor, or the annuity discount factor).
I go through this in the previous lecture.
cediva20 says
Thank you for help.
One question though..in the test post the chapter I’m not understanding why 8% was used to arrive at the IRR of 18%. I did get 18% but this was done the long way.
Please assist
John Moffat says
I don’t know what you mean by ‘the long way’- there is only one way of doing it, making two ‘guesses’ and then approximating between them.
Since we had already been asked to calculate the NPV at 12%, we had one value. You could try any rate of interest for the second value – my answer tried 20%.
(8% is the difference between 20% and 12%).
cediva20 says
Thank you
John Moffat says
You have asked this question twice, and I have already replied to the first one.
Morganne says
This was very helpful thank u but can u work this question for me plz
An investment has the following inflows and outflows
Time Cash flow per annum
0 (20,000)
1-4 3,000
5-8 7,000
10 (10,000)
What is the net present value of the investment at a discount rate of 8% ?
Farzana sultana says
is the answer -97265
Farzana sultana says
sorry,the answer should b this one -36935.i made a mistake first time