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Comments

  1. Hi John,

    Just a quick question, if the question had stated that the fixed overheads are not absorbed and extra is needed, how will I treat that? is it the same principle as working capital in example 3?

  4. Hello Sir,

    I have a question regarding inflation.
    If we also had a general inflation rate on example number 5, how would we deal with inflation. would we inflate the material, labour and selling price twice? would we also inflate the overheads and other expenses as well with the general inflation rate?

    thanks

    • No – if there is a specific rate given for a particular flow, then you only inflate at that rate. You would only apply the general rate to flows that you were told inflated at the general rate. (The general rate is like an average inflation rate and is only normally relevant for calculating the nominal rate when you now the real rate, and vice versa).

  5. hello,

    If this type of question comes up in the exam, will i get marks if i use excel formuls and do not show working like you did in this example 5.
    excel formula example, material inflation
    A1 inflation 108%
    A2 quantity 100,000
    A3 cost $8
    this would be as in year 1 =A1*A2*A3
    answer will show= 864,000

    Thank you

    • You must in future ask this sort of question in the Ask the Tutor Forum and not as a comment on a lecture 馃檪

      However it should be clear to you from the other lectures (and the Paper F2 lectures on this, because it is revision of F2) that the IRR is independent of the cost of capital and therefore an increase in the cost of capital has no effect on the IRR. Also (again from the earlier lectures) it should be clear that the higher the cost of capital then the lower the NPV. Please do watch all of the lectures (and, if necessary, the relevant Paper F2 lectures).

      • Yes sir, I’ll keep that in mind from the next queries I have. But my doubt about the cost of capital not changing IRR is still not cleared as we take the lower cost of capital rate and higher cost of capital rate to calculate the IRR.

      • But we do not do that to calculate the IRR! We use any two ‘guesses’ at the interest rate in order to calculate the IRR. It just makes sense to use the cost of capital as one of the guesses if we have already had to calculate the NPV at the cost of capital.
        Again, I do suggest you watch the lectures on IRR, and if necessary the Paper F2 lectures on IRR.
        The IRR is (by definition) the rate of interest at which the NPV is zero, which is completely independent of the cost of capital.

  7. sir I have a doubt in example 4 .Say if we proceed with the project we invest in the machine, then wont we buy the materials immediately and start production. So why are inflating price of material in 1 year time. i could understand it if investing in machine was also consider in 1 years time but we assume that m/c is purchased now (i.e in 0 year time) so materials should also be purchased now to start production.

    • We always assume that operating flows (such as sales revenue, purchases etc.) occur at the end of years unless told otherwise – so the first flow for material will be at time 1 and will have one years inflation.

      In practice they are more likely to be purchased evenly throughout the year (and maybe inflate also evenly throughout the year) and the payment (which is what would be relevant) is likely to be sometime after the purchase. However that would make things very complicated (and be completely outside the scope of F9 (and P4) and so we always assume end of year.

      There is no way they would buy inventory to last the whole year at the start of the year. They will obviously need to buy some goods at the start of the year, but this is effectively part of the working capital requirement.

    • The 401 is the operating cash flow, which is the profit before depreciation (i.e. the cash flow, which is what we need).

      The capital allowance is another word for tax allowable depreciation (which you should understand from paper F6 or whatever you exempted you from F6).

      For tax purposes the capital allowances reduce the tax payable, so although (as you can see from the printed answer in the lecture notes) there are two ways of arriving at the same answer, the easiest way is to calculate what the tax would be on the cash profits (i.e. the operating cash flows, the profit before depreciation) and then calculate separately the tax saving from the tax allowable depreciation (the capital allowances).

  9. We are purchasing materials at the current price throughout the 1st year and then just paying for it at the end. We know the current price as it is given in the question. Then why inflation applies for time 1 (or 1st year) as we are purchasing the materials at current price in 1st year ?

  10. John,
    just out of curiosity i wanted to know what happens to the taxable amount in the last year?
    Because we just worked out till the balance allowance and 30% of 575 and we got the tax savings.
    But what was the actual taxable amount?

    PS.Another amazing lecture video John!
    Thanks a bunch.
    Your explanation makes it very easy to understand the concepts.

    • The actual taxable amount is the operating profit less the balance allowance.

      Easier in F9 is to calculate the tax on the operating profit and the sax saving on the allowance separately.

      (And thank you for the comment 馃檪 )

      • Thanks John 馃檪
        My exam is in 2 weeks.
        Wish me luck! 馃榾
        Cheers! 馃檪
        And keep up the good work.

  11. John

    I may have missed your explanation if this question was asked . We do not inflate year 1 sale price of 20 in your calculation but start inflating from year 2.
    All expenses are inflated from year 1.
    Bit confusing – even the question says the price of $20 in the first year I still do have this question – why the sale price is not inflated in year 1 ?

    thanks

    • If the question says that the price will be $20 in the first year, then it will be $20. How can it inflate if we have decided to fix our initial selling price at $20?

      With costs on the other hand, it is less likely that we will know what the cost will be in the first year (we haven’t even bought the machine now). What we will know is the current price, but by next year (the first year of the having the machine) then it will have inflated.

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