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FM Chapter 9 Questions – Discounted cash flow – further aspects

VIVA

 

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  1. Hi John,

    For the last question, isn’t it better to not do project A at all and do project B 1 and a half times? That would give an NPV of $7200. Or in the exam, can you not do the same project multiple times?

    Thanks

  3. Hi Sir,

    Q1: What’s the error for and how to correct “Tax Allowance Depreciation is a relevant cash flow when evaluating borrowing to buy compared to leasing as a finance choice?

    What’s the error for and how to correct “Asset replacement decisions require relevant cash flows to be discounted by the after-tax cost of debt”
    Thanks in advance.

    • The answer to both your questions appears when you have submitted your own answers!

      Depreciation is never a cash flow – it is used to calculate the tax, but is not a cash flow.

      Investment decisions are discounted at the WACC, not just at the cost of debt.

      Did you watch the free lectures before attempting this test?

  5. Hi,
    In my test Q# is 1 and it has four option to choose correct one, my inquiry is on one of the option which says asset replacement decision require cash flow to be discounted by after tax cost of debt, this is true what I knew but answer says no, it should be discounted with weighted average cost of capital, I am wondering I did not see any use of weighted average cost of capital in investment appraisal chapters. Asset replacement require calculation of optimum replacement cycle which require post tax cost of capital, could you please elaborate answer why to choose WACC and how to find that at this stage of FM course.
    Thanks

    • I assume you are asking about Question 4? (Please say which question in future).

      Since the question says we are replacing every 2 years, it is only the scrap value at the end of 2 years that is relevant. (We are not scrapping at the end of the first year!!)

      Have you watched my free lectures on replacement? If not, then I do suggest that you do.

  8. A lease agreement has an NPV of 32000 at a rate of 10%. Lease has 5 equal payments payable at the start of each year.

    So Y0 payments begin. So time 1-4 in perpetuity. 32000/3.170 to find the annual payment amount 10095?

    • The annual payment is 7,674

      If the payment is X per year, then the PV of the first payment at time 0 is X
      The PV of the remaining 4 payment (1 to 4) is 3.170X

      So the PV of all 5 payments = X + 3.170X = 4.170X = 32,000
      X = 32,000 / 4.170 = 7,674

      (Incidentally, 1 – 4 is an annuity, not a perpetuity. A perpetuity is every year for ever)

      • Thank you. I got it now, and yes, I confused the term annuity with perpetuity….not enough coffee lol.

        Could I take the same approach for all questions like this. So say the annuity factor for T4 is 3.170, and just add 1.
        So annuity of N+1 . So Principle / N+1?

      • What would happen if the flows started at T1 instead of T0. I am guessing we do not add X onto the annuity factor.
        So instead of 3.170X becoming 4.170, it will just be a straight forward division using 3.170?

      • Multiplying the amount each year by the annuity factor gives the present value.

        Here we know the present value and so we divide by the annuity factor to get the amount each year.

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