2.589 is from the annuity tables that are also provided. The difference is simply due to the fact that both sets of tables are rounded to 3 decimal places. If you are unsure about the use of annuity tables then you should watch the earlier lectures (and if necessary the Paper MA (was F2) lectures on discounting, because this is revision from Paper MA).

By all means discount each flow individually if you prefer. The fact that the answer will be slightly different is irrelevant (both in real life and in exams).You would still get full marks in the exam.

A company is considering an investment of $800,000 in new product. The product is expected to yield incremental net cash flows over the next five years as follows: Year Cash flows ($) Year-1: 175,000 Year2: 225,000 Year3: 340,000 Year4: 165,000 Year5: 125,000 Cash flows are expected to grow at a rate of 3% per year after year five to infinity. Assume a discount factor of 14%. The net present value of the project is?
A. $430,500
B. $526,021
C. $811,412
D. $650,119

Answer is B

Sir I would appreciate if you can explain with detailed working.

I am confused about the following part of the answer:
PV 6 to infinity (125,000 x 1.03)/(0.14 – 0.03) = 1,170,454 x 0.519 = 607,466?

Full answer is as follows:

PV 1–5: 718,555?
PV 6 to infinity (125,000 x 1.03)/(0.14 – 0.03) = 1,170,454 x 0.519 = 607,466?
Total present value 1,326,021?
Less initial investment (800,000)
Net present value 526,021

It means (and means in the exam also when phrased this way) that from now on they are $140K per year more than they are now. It does not mean that they go up another $140K every year.

I have been confused there because the question said ……contribution of 50%.
But your statement made me clear (i.e contribution is 50% of selling price).

mufc96 says

Hello,

Why is the PV contribution instead of the PV of the Sales Revenue, to compute the NPV?

Thank you

John Moffat says

The contribution is the revenue less the variable costs.

k5031146 says

May I ask why shouldn’t we calculate the PV for each year and adding them up? Cause the NPV will be different.

E.G. 0 yr Cost : (200000)+ 1st yr: (265000-140000)*0.833(cost of capital) + and so on?

Thank you in advance.

k5031146 says

Also, as per the table in the notes, the df@20% should be 2.588 instead of 2.589 (0.830.694+0.579+0.482). Is there any reason to state it as 2.589?

If I take 2.588 in exam, would it be wrong? Thank you again.

John Moffat says

2.589 is from the annuity tables that are also provided. The difference is simply due to the fact that both sets of tables are rounded to 3 decimal places. If you are unsure about the use of annuity tables then you should watch the earlier lectures (and if necessary the Paper MA (was F2) lectures on discounting, because this is revision from Paper MA).

By all means discount each flow individually if you prefer. The fact that the answer will be slightly different is irrelevant (both in real life and in exams).You would still get full marks in the exam.

hashirhashmat says

A company is considering an investment of $800,000 in new product. The product is expected to yield incremental net cash flows over the next five years as follows: Year Cash flows ($) Year-1: 175,000 Year2: 225,000 Year3: 340,000 Year4: 165,000 Year5: 125,000 Cash flows are expected to grow at a rate of 3% per year after year five to infinity. Assume a discount factor of 14%. The net present value of the project is?

A. $430,500

B. $526,021

C. $811,412

D. $650,119

Answer is B

Sir I would appreciate if you can explain with detailed working.

hashirhashmat says

I am confused about the following part of the answer:

PV 6 to infinity (125,000 x 1.03)/(0.14 – 0.03) = 1,170,454 x 0.519 = 607,466?

Full answer is as follows:

PV 1–5: 718,555?

PV 6 to infinity (125,000 x 1.03)/(0.14 – 0.03) = 1,170,454 x 0.519 = 607,466?

Total present value 1,326,021?

Less initial investment (800,000)

Net present value 526,021

John Moffat says

You must ask this kind of question in the Ask the Tutor Forum and not as a comment on a lecture.

As far as the discounting is concerned, this is all explained in later lectures.

tankarki says

Question says Fixed OH to be increase by $140K per year but we have taken $140K per year only ?

John Moffat says

It means (and means in the exam also when phrased this way) that from now on they are $140K per year more than they are now. It does not mean that they go up another $140K every year.

shram says

Hi sir ,

For finding contribution,

Why we have used selling price p.u instead of contribution p.u?

John Moffat says

The question says that the contribution is 50% of the selling price and that is what I have done in the lecture.

shram says

Now I am clear.

Thank you sir.

I have been confused there because the question said ……contribution of 50%.

But your statement made me clear (i.e contribution is 50% of selling price).

shram says

I just need to appreciate a lot more for the way of representation of question.

Otherwise,

The concept was easy-peasy.

asher2019 says

Thank you