Hi Sir, When we total up the PV of 4 timings in the example it, should we call it NPV? (Just to clarify as in this video it’s written in “PV”, not NPV). Thanks.

What you call things is really of little relevance!!

The present value of a cash flow is the present value of an individual flow (or flows). The net present value if the sum total of the present values of all the cash flows.

If you are still unsure then it may help you to watch the Paper F2 lectures on investment appraisal, because this is basic revision of Paper F2 馃檪

Sir, NPV for every 2 years was $72972 and for 3years it was $87101. What I wanted to ask you is that why can’t we compare both those NPV value? Because after all we have we have discounted!!! Why it is necessary to find EAC to compare? Like what’s the science behind it?

Could u pls explain the reason for not considering scrap value in the 2 yr replacement calculation ? The scrap value is considered while calculating 1 yr and 3 yr replacement.

mr John, why do we omit the scrap values on previous years but included the scrap for year 3 only? like when we calculate the present values for year 3?

I’ve watched your lecture but I still don’t get the rationale behind adjusting nominal value in step one to NPV, then adjust it again using annuity. I mean in theory, isn’t it the same as we use the average nominal cost and adjust it using discount factor?

I am sorry but I don’t know what you are suggesting.

We are not adjusting anything – we are calculating the PV for one cycle (which is the equivalent outlay at time 0) and then given that the cycle will be repeated to infinity we are calculating the outlay per year that would be equivalent so that we are able to compare the different replacement cycles. I can only suggest that you watch the lecture again.

I am afraid that you are going to have to watch the lecture again, because I do explain this in the lecture.

We can only compare the EAC’s when it is a replacement decision – it is not logical to try and compare an NPV that repeats every 2 years with one that repeats every 3 years.

I understand that you mentioned there’s still another method of dealing with asset replacement in mutually exclusive projects with unequal lives. Would that be the replacement chain method using the shortest common multiple of the alternatives’ lifes? And if so, is it included in the Dec 2013 Syllabus or there’s no point bothering with it?

You can certainly do it that way and you will get full marks. However the examiner has never required you specifically to do it that way, whereas he has in the past specifically asked you to calculate the equivalent annual cost. So there is not really any point in learning two ways.

Sir, some text books solved the problem without using the maintenance cost in year one, and i don’t know if that is correct and beside there was no assumption stated . Please kindly expatiate on this issue

I think you might be referring to an example in the Kaplan book. If you are then it specifically says that the maintenance is paid in the following year. There is no specific issue involved – as always with operating cash flows, you assume that the first years cost is payable in one years time i.e. at time 1, unless you are told differently.

Thank u Prof. . U are a wonderful teacher i wish u were the teacher for all the courses , cos your passion for teaching makes us to understand the course the more.

sir.in KAPLAN BOOK.. they say that and i quote…”note that the asset is only maintained at the year end if it isto be kept for a further year i.e ther are no maintaince cost in the year of replacement…”… but u have included running cost in year of disposal or scrap….plese guide me..im bit confused……………………reply promptly…..i will be obliged

@faizan1185, Your quote is not a general rule – it is just part of that particular question.

You will always have running costs in the year of replacement (otherwise the machine will not be working in the final year!) and you will usually also have maintenance costs in the final year as well.

Think about a car – if you replace it at the end of a year then you will still have to pay for running it during that year and for repairing (maintenance) during that year!

Always assume this unless the question says differently. The question you are referring to in Kaplan specifically tells you to do differently (although it is unusual for it to say that) and so you do what you are told.

Sun says

Hi Sir,

When we total up the PV of 4 timings in the example it, should we call it NPV? (Just to clarify as in this video it’s written in “PV”, not NPV). Thanks.

John Moffat says

What you call things is really of little relevance!!

The present value of a cash flow is the present value of an individual flow (or flows). The net present value if the sum total of the present values of all the cash flows.

If you are still unsure then it may help you to watch the Paper F2 lectures on investment appraisal, because this is basic revision of Paper F2 馃檪

Sun says

Hi Sir,

Thanks for replying. I knew it. Therefore for the sum up of PV in three timings= 72972=> shall we say it’s NPV?

John Moffat says

No, because we are only looking at costs (we do not know the revenues and we do not need to know the revenues to make the decision).

The 72,972 is the PV of the costs.

loukasierides says

Dear Sir,

Your lectures as always are such a great help, thank you very much!

John Moffat says

Thank you for your comment 馃檪

nomadd says

Sir,

NPV for every 2 years was $72972 and for 3years it was $87101.

What I wanted to ask you is that why can’t we compare both those NPV value? Because after all we have we have discounted!!! Why it is necessary to find EAC to compare? Like what’s the science behind it?

Thankyou.

John Moffat says

Science has nothing to do with it 馃檪

As I explain in the lecture, how can you compare paying out 72972 every 2 years with paying out 87101 every three years? It is not a valid comparison.

nomadd says

Thankyou sir for making it clear!!!

John Moffat says

You are welcome 馃檪

devaoff says

Hello Sir,

Could u pls explain the reason for not considering scrap value in the 2 yr replacement calculation ? The scrap value is considered while calculating 1 yr and 3 yr replacement.

Thanks and Regards

John Moffat says

But the scrap value certainly is considered!!! I suggest that you watch the lecture again, because I do bring it in 馃檪

Moloantoa says

mr John, why do we omit the scrap values on previous years but included the scrap for year 3 only? like when we calculate the present values for year 3?

regards

John Moffat says

But you only scrap the machine once!!!

You scrap it at the end of its life.

Mahrukh says

Hi john,

If not specifically asked to calculate EAC, can we do it this way,

72972/2 = 36486/yr

87101/3 = 29034/yr ?

John Moffat says

No – it would not make any sense because of the difference in the timing of the flows.

trychandararith says

Hi sir,

I’ve watched your lecture but I still don’t get the rationale behind adjusting nominal value in step one to NPV, then adjust it again using annuity. I mean in theory, isn’t it the same as we use the average nominal cost and adjust it using discount factor?

Thanks.

John Moffat says

I am sorry but I don’t know what you are suggesting.

We are not adjusting anything – we are calculating the PV for one cycle (which is the equivalent outlay at time 0) and then given that the cycle will be repeated to infinity we are calculating the outlay per year that would be equivalent so that we are able to compare the different replacement cycles.

I can only suggest that you watch the lecture again.

Sali says

Hi Mr. Moffat,

I did not get the difference between the NPV ($72.972) and the EAC ($44.878) replacing the machine every 2 years for ever.

And what figure guide us to the decision is comparing the NPV of $72.972 and $87.101 or the EAC of $44.878 and $38.152.

Thanks in advance Sir.

John Moffat says

I am afraid that you are going to have to watch the lecture again, because I do explain this in the lecture.

We can only compare the EAC’s when it is a replacement decision – it is not logical to try and compare an NPV that repeats every 2 years with one that repeats every 3 years.

Sali says

Thanks Sir. ?

John Moffat says

You are welcome 馃檪

acca2050 says

Can we do 1st year replacement and see whats the results, then try and 2nd and 3rd, this we choose the best?

John Moffat says

Of course. That is what I do in the lecture – it doesn’t matter which order you do them in!

nkmile64 says

A very good lecture indeed!

I understand that you mentioned there’s still another method of dealing with asset replacement in mutually exclusive projects with unequal lives. Would that be the replacement chain method using the shortest common multiple of the alternatives’ lifes? And if so, is it included in the Dec 2013 Syllabus or there’s no point bothering with it?

John Moffat says

You can certainly do it that way and you will get full marks. However the examiner has never required you specifically to do it that way, whereas he has in the past specifically asked you to calculate the equivalent annual cost. So there is not really any point in learning two ways.

nkmile64 says

Understood!

Thanks John

osuja says

Sir, some text books solved the problem without using the maintenance cost in year one, and i don’t know if that is correct and beside there was no assumption stated . Please kindly expatiate on this issue

John Moffat says

I think you might be referring to an example in the Kaplan book. If you are then it specifically says that the maintenance is paid in the following year.

There is no specific issue involved – as always with operating cash flows, you assume that the first years cost is payable in one years time i.e. at time 1, unless you are told differently.

osuja says

Thank u Prof. . U are a wonderful teacher

i wish u were the teacher for all the courses ,

cos your passion for teaching makes us to understand the course

the more.

jeweltrinidad says

john always makes me understand by the way he lectures

Rana Mateen says

jhonmoffat always great

faizan1185 says

ok sir….thanks for taking time to reply……..

faizan1185 says

sir.in KAPLAN BOOK.. they say that and i quote…”note that the asset is only maintained at the year end if it isto be kept for a further year i.e ther are no maintaince cost in the year of replacement…”… but u have included running cost in year of disposal or scrap….plese guide me..im bit confused……………………reply promptly…..i will be obliged

John Moffat says

@faizan1185, Your quote is not a general rule – it is just part of that particular question.

You will always have running costs in the year of replacement (otherwise the machine will not be working in the final year!) and you will usually also have maintenance costs in the final year as well.

Think about a car – if you replace it at the end of a year then you will still have to pay for running it during that year and for repairing (maintenance) during that year!

Always assume this unless the question says differently. The question you are referring to in Kaplan specifically tells you to do differently (although it is unusual for it to say that) and so you do what you are told.

shem436 says

very helpful. Thank you opentuition.

adilali1990 says

great lecture i love teachers of opentuition