Sorry for being dense but why does the scrap value also need to have the discount factor applied? Is the idea that it makes up for potential effects of inflation?
M
mrjonbainModerator·
Its sti?l a likely cashflow to be received in the future. The future as a whole needs to be discounted. Would yoou prefer money now or in the future?
R
Rachel·
Ahhh understood, thank you for your help
L
Leslie·
Using your method of calculating IRR, what would we do in the case where the second interest rate does not give a deficit?
M
mrjonbainModerator·
Choose a higher rate?
E
emily·
ohhh okay thank you so much
E
emily·
I got 0.1377 where did I go wrong
J
John MoffatTutor·
I do not know which part of the calculation you are referring to (and how you arrived at 0.1377 anyway).
E
emily·
for example 2 I put in your working out into my calculator. [10/100 +(6660/8820 x 5/100)]
E
emily·
and it gave me that answer is there something wrong with my calculator
E
emily·
you know how there are 3 tables how would you know which one to use in an exam like for the first example I somewhat understand why you used the present value table
J
John MoffatTutor·
The tables are all headed up and only two of them related to discounted cash flow (the other is the normal distribution table). My lectures explain the relevance of all three and when (and how) to use them.
D
Driedmango·
I don't understand why you do 6660/8820 x 5%, why did you use 6660??
J
John MoffatTutor·
Because that was the NPV at 10% and is the change in NPV needed to get to an NPV of zero.
P
Poloko·
Hello Sir, I don't understand why 8820 changed to a positive number because you said from 6660 to -2160, the change is negative 8820. So why did you write it as positive on the fraction?
J
John MoffatTutor·
Either the 6660 and the 8820 are both positive or they are both negative - it doesn't matter and gives the same result.
S
Sargis·
Mister in the mock exam there is Accounting rate of return, and the statement incloudes incremental costs per year, and adition revenue per year. How to deal with it?
P
Pabatso·
Sir i did not understand and where you said at the interest of 5% the NPV will be -8820 if i am right
J
John MoffatTutor·
I did not say that! The difference between +6,660 and -2,160 is 8,820.
H
Helena·
Hey Joseph...I thought a decrease from 6,660 to 2,160 would be 4,500...how does it come to be 8820.
H
Helena·
Sorry, my bad...hadn't followed through properly
J
John MoffatTutor·
No problem - I trust that you are now OK with it :-)
S
Syeda Zainab·
hi sir for example 1, I got negative 6660. 80000 -18180 - 2478-0 - 30040 - 13660 = -6660
J
John MoffatTutor·
The 80,000 is an outflow and so is negative. The other flows are inflows and are positive.
The net total is therefore positive.
S
Syeda Zainab·
ohh okay got it ! thank you so much for the help. your lectures are great!
W
Walter Acika·
a) Project E is a strategically important project which the board of the TM Co have decided should be undertaken in order for the company to remain competitive. Information relating to the future cash flows of this project are as follows:
Year 1 2 3 4
Sales volume (units) 12,000 13,000 10,000 10,000
Selling price ($per unit) 450 470 500 500
Variable Cost ($per unit) 260 280 295 320
Fixed costs (‘000) 750 750 750 750
These forecasts are before taking into account of selling price inflation of 5.5% per year, Variable cost inflation of 6.5% per year and fixed cost inflation of 3% per year. The fixed costs are incremental fixed costs which are associated with project E. At the end of four years, machinery from the project will be sold for scrap with a value of $400,000. Tax allowable depreciation on the initial investment cost of the project is available on machinery at 25% reducing balance basis and the Company pays corporation Tax of 30% per year, one year in arrears. A balancing charge or allowance is available at the end of the four years of operation. The Company has a nominal after-tax cost of capital of 13% per year. The initial investment for Project E is $5,000,000
Required:
Calculate the Net Present Value (nominal after-tax NPV) of project E and comment on the financial acceptability of the project.
J
John MoffatTutor·
There is no point whatsoever in typing out a full question here and expecting to be provided with a full answer. This is for comments on the actual lecture!!!
Ask in the Ask the Tutor Forum, but again there is no point in simply expecting me to provide a full answer. You must have an answer in the same book in which you found the question and so ask (in the Ask the Tutor Forum) about whatever it is you are not clear about in the answer, and I will explain. (If you do not have an answer because you have been given this as an assignment, then obviously we are not going to do your homework for you :-) )
K
kamo7293·
To sate my curiosity, I redid Example 1 with the interest rate at 13.78% and the final NPV I got was -160. obviously that came from rounding error. Just wanted to post it since I was expecting you to do it just to prove it really did make NPV 0
J
John MoffatTutor·
:-)
H
Hiền·
Hi all, I have a question related to the impact of Working capital interest expense on the NPV calculation. From what I've learned, normally we will use the post-tax interest rate of long-term liabilities to calculate the WACC which will be used to discount the cashflow to generate the NPV, and the interest expense will be excluded from the cashflow calculation. However, I don't know what is the treatment of interest expense on the working capital. In ACCA test kits, normally they ignore the interest expense which we have to pay for acquiring additional WC, they neither include such expense in cashflow calculation nor the WACC. What if the working capital contributes a large part of finance needed, a commodity trading company for example. What should we do? Put the interest expense to cashflow calculation and remove it from WACC or should we use it to calculate WACC? If the latter option is selected, how do we calculate WACC since the additional WC may vary over the time.
Your answer is greatly appreciated.
J
John MoffatTutor·
Calculation of the WACC is not in the syllabus for Paper MA !! It is not examined until later papers.
A
Annsh·
While calculating IRR,
6660/8820 x 5% = 0.0378
Pls help
J
John MoffatTutor·
0.0378 is the same as 3.78%
S
Samrah·
Salam
Dear Sir,
Before subtracting the value 80000 my sum of present values of each year is 86688, should i consider it correct. Its my first time tell me i shall be very thankful.
J
John MoffatTutor·
It depends whether or not you choose the tables. The ables are only to three decimal places which makes it a bit different. The difference is irrelevant in the exam.
M
Mannan·
How is it okay to accept the project even if the surplus comes out to be only +1?
J
John MoffatTutor·
Because they would be better off - even if it is just $1 !!
In practice we might not prepared to take the risk when the benefit is only $1, but discussion of this is not relevant until Paper FM).
M
Mannan·
If we instead kept $80,000 in the bank then we would have earned interest of $8,000, $8800, $9680, $10,648 respectively in each of the 4 years. this is our loss as we will not get this interest because of this investment. So to get the amount we will actually earn in these four years, why don't we subtract each of the amounts I mentioned above from $20,000, $30,000, $40,000, $20000 respectively?
J
John MoffatTutor·
Discounting is taking account of that.
I
Iyk·
Assuming we were not given the NPV at 15%, and we are to derive the IRR using only the NPV at 10% with the Knowledge that NPV at 0% will be $30,000. I.e., $110,000 - $80,000.
The IRR would be 12.85% which is less than your value at 13.77%
J
John MoffatTutor·
That would be fine. As I explain in the lecture an IRR calculated using 2 'guesses' is only ever an approximation, and the further apart the two rate are then the worse will be the approximation.
H
Hermela·
Sir it is a nice lecture but I don't get the concept ... If one factory invest on 80000 machine it is worthy the get only 6660 profit after 6 years?
J
John MoffatTutor·
$6,660 is not the profit. It is the cash surplus expressed in present value terms (the are getting back the 80,000 and making a surplus of 6,660). If they can find something else to do with their $80,000 then they will do that instead. If there is nothing else to do with their $80,000 then they would be silly just to leave it sitting there!
S
Sabyasachi·
Sir, I tried doing this IRR sum with 20% instead of 15% and the answer was 14.07%
Is this variance normal or should the answer have been 13.78% ?
J
John MoffatTutor·
Yes, it is no problem. The answer is always approximate because the relationship is not linear.
D
Daniel·
Splendid job, Sir Moffat!! Exceptionally done as usual :D
J
John MoffatTutor·
Thank you for your comment :-)
A
Alex·
Hi sir,
I cannot understand why we remove the interest for the full $110,000 in the first example. If we are paying $80,000 aren't we paying interest on that?
Thank you, your lectures are great :)
J
John MoffatTutor·
We are 'removing' interest on the receipts in order to find out how much 'now' is equivalent to the receipts. If it is more than the original investment then it is worth investing. If it is less, then it isn't worth investing.
A
Alex·
But are we not over compensating for the interest? Shouldnt the interest be on what we pay not earn?
J
John MoffatTutor·
Not at all.
As I explain in the lectures, we could calculate the terminal value instead and would arrive at the same decision. However we always look at the present value instead because it makes it easier to (for example) compare investments which last for different periods.
A
Asif·
Dear sir, I was trying to the do NPV using (FV x 1.r^-n ) formula [I find this way quite quick to compute compared to FV x 1/(1.r^-n) ] and I see the answer using the formulas could differ upto more than 10-15 digits, per calculation, from the Present value tables at times. Could this not pose as a problem during the exam, if the answer is a fill in the blank type answer instead of mcq ?
A
Asif·
Correction : compared to FV x 1/(1.r^+n)
J
John MoffatTutor·
No it won't be a problem in the exam. Questions will ask for the answer to be (for example) to the nearest thousand.
Nobody worried about a few thousand in real life, and nor is it a problem in the exam :-)
A
Asif·
Thanks ?
A
Asif·
It was a smiley, but the website converted it to a Question mark. Haha
Sir, what about IRR, same rounding to nearest figure in exam ?
J
John MoffatTutor·
Yes :-)
S
sruthiann·
Sir,
For the above question in the comment, do we take the additional revenue as the cash flows per year minus the extra cost?? because we are not provided with any other cash flows, and we do this using annuity table right??
C
cynthiamyint·
Hi Sir,
I know how to calculate NPV and IRR % but I got some tricky question in the exam.
I would like to ask about my previous some exam question which I was failed.
(Not exactly but some I still remember)
Given net cash flow $9500 for 5 years ,cost of capital 12%
Q1@ ask me to find investment if NPV $20000 (this amount not sure may be $2000 )
Q2@ ask me to find investment amount if IRR 18%...
Can you help me how to calculate?
Thanks,
Cynthia
J
John MoffatTutor·
In future, please ask this kind of question in the Ask the Tutor Forum, and not as a comment on a lecture.
For the first question, you first discount the 9,500 cash flows by multiplying by the 5 year annuity discount factor at 12%.
You then subtract 20,000 and this tells you what the initial investment will be.
For the second question, the IRR is the interest rate at which the NPV equals zero. So discount the 9,500 cash flows by multiplying by the 5 year annuity factor at 18%. The initial investment must equal the present value of the cash flows that you have just calculated.
E
elainew·
Great lecture! But I am a bit confused.. For the NPV, why are we applying the discount factor to the cash generated amount and not to the 80,000? For example, if we had borrowed 80,000 for the project at 10% rate, at the end of the 4 years period we would have paid in total (including interest) 117,128 and earned 110,000 (cash generated + scrap value of project), which would let us with a 7,128 cash deficit. I don't understand that approach :/, is there any tip to help me to see what I am missing? Thanks a mil!!
J
John MoffatTutor·
It would. seem that you have not watched the previous lectures on interest and on discounting, because I do explain in these lectures what is happening with discounting and why.
(The reason you would not end up with your cash deficit is because when you receive the money each year you will be using to pay back some of the borrowing and so the interest will be a lot lower.)
Still trying to get my head around this, having watched all the previous lectures and still not getting it, I think I am having the same misunderstanding as Elaine above.
What I don't understand is that, if we assume the interest would be received on cash (rather than payable on borrowing), it amounts to higher than the 110,000 on the project. Other than using the DF, I can't see how this positive NPV is logically earning more than if we simply earned interest on the cash, instead of the project, which would be £117,128.
My only guess is that this is due to the fact that the return amount say for year 1 is £20,000 which is then effectively freed up capital with further interest earning potential? So the overall benefit of the project would essentially be the £110,000, plus the potential interest earned on the receipts generated each year?
Are we therefore using the DF to determine how much is needed to invest today, to receive the £20,000 after 1 year? Surely the real opportunity cost is the actual interest on the £80k which amounts to more than the £110k? Unless the £20,000 after 1 year is then available for further interest?
To understand, I just need to clarify if we are assuming that the £20k earned after 1 year, and subsequent years earnings has future earning potential in addition to the £80K invested? So its a matter of receiving higher return on capital sooner (with additional earnings potential), than overall amount generated by project vs interest on the £80k?
Thanks so much, I find your videos really helpful!
Lou
S
Sadaf·
There is a formula also discount factor = 1/(1+r)^n
Where r is the interest 10%= 0.1
And N is the period
J
jwang8·
classic! way better than my actual teacher.
J
John MoffatTutor·
Thank you for your comment :-)
J
John MoffatTutor·
You take the present value tables, and look at the column headed up 10% and the row for 1 period.
S
syedsami·
can u say how do we get the discount factor?
J
John MoffatTutor·
I explain how to get the discount factors in the lectures covering the previous chapter of our notes!!!
A
Amg·
i got lost getting to the IRR=13.78,from the lecture,it says IRR = 10% + (6660/8820 X 5%)
= 10% + 3.78% ??????
I get totally different answers.....off the grid,please help!!
S
samirh·
I am having the same issue, did you figure it out?
J
John MoffatTutor·
Divide 6660 by 8820, multiply the answer by 5 and you get 3.78.
Add 3.78 to 10 and you get 13.78.
G
Gabriel·
i got a little lost, +6660 and -2160 is 8820? or in this step we just ignore the mathematical signs and just do regular addition?
J
John MoffatTutor·
The difference between +6,660 and zero is 6,660
The difference between + 6,660 and - 2,160 is bigger and is 8,820.
This is standard arithmetic :-)
S
saroj·
Able ltd is considering a new project for which the following information is available:
Initial cost - $300,000
Expected life – 5 years
Estimated scrap value – $20,000
Additional revenue from the project – $120,000 per year
Incremental cost of the project – $30,000 per year
Cost of capital – 10%
A) calculate the Net present Value of the project (to the nearest $)
Please answer this for me as i am bit confused about how to deal with incremental costs.
J
John MoffatTutor·
You must ask this kind of question in the Ask the Tutor Forum and not as a comment on a lecture.
The word incremental means extra - so incremental costs are extra costs.
S
sruthiann·
Sir,
For the above question in the comment, do we take the additional revenue as the cash flows per year minus the extra cost?? because we are not provided with any other cash flows, and we do this using annuity table right??
D
David·
hi sir, how solve this question?
Using an interest rate of 10% per year the net present value (NPV) of a project has been correctly calculated as $50. If the interest rate is increased by 1% the NPV of the project falls by $20.
What is the internal rate of return of the project?
11.7%
20.0%
7.5%
12.5%
J
John MoffatTutor·
You know that the NPV at 10% is $50.
You know that the NPV at 11% (10 + 1) is $30 (50 - 20).
Now you have two 'guesses' and you continue as I do in the example in my free lectures.
D
David·
tqvm sir for yr quick response. May God continue to bless u
The net total is therefore positive.
Year 1 2 3 4
Sales volume (units) 12,000 13,000 10,000 10,000
Selling price ($per unit) 450 470 500 500
Variable Cost ($per unit) 260 280 295 320
Fixed costs (‘000) 750 750 750 750
These forecasts are before taking into account of selling price inflation of 5.5% per year, Variable cost inflation of 6.5% per year and fixed cost inflation of 3% per year. The fixed costs are incremental fixed costs which are associated with project E. At the end of four years, machinery from the project will be sold for scrap with a value of $400,000. Tax allowable depreciation on the initial investment cost of the project is available on machinery at 25% reducing balance basis and the Company pays corporation Tax of 30% per year, one year in arrears. A balancing charge or allowance is available at the end of the four years of operation. The Company has a nominal after-tax cost of capital of 13% per year. The initial investment for Project E is $5,000,000
Required:
Calculate the Net Present Value (nominal after-tax NPV) of project E and comment on the financial acceptability of the project.
Ask in the Ask the Tutor Forum, but again there is no point in simply expecting me to provide a full answer. You must have an answer in the same book in which you found the question and so ask (in the Ask the Tutor Forum) about whatever it is you are not clear about in the answer, and I will explain. (If you do not have an answer because you have been given this as an assignment, then obviously we are not going to do your homework for you :-) )
Your answer is greatly appreciated.
6660/8820 x 5% = 0.0378
Pls help
Dear Sir,
Before subtracting the value 80000 my sum of present values of each year is 86688, should i consider it correct. Its my first time tell me i shall be very thankful.
In practice we might not prepared to take the risk when the benefit is only $1, but discussion of this is not relevant until Paper FM).
The IRR would be 12.85% which is less than your value at 13.77%
Is this variance normal or should the answer have been 13.78% ?
I cannot understand why we remove the interest for the full $110,000 in the first example. If we are paying $80,000 aren't we paying interest on that?
Thank you, your lectures are great :)
As I explain in the lectures, we could calculate the terminal value instead and would arrive at the same decision. However we always look at the present value instead because it makes it easier to (for example) compare investments which last for different periods.
Nobody worried about a few thousand in real life, and nor is it a problem in the exam :-)
Sir, what about IRR, same rounding to nearest figure in exam ?
For the above question in the comment, do we take the additional revenue as the cash flows per year minus the extra cost?? because we are not provided with any other cash flows, and we do this using annuity table right??
I know how to calculate NPV and IRR % but I got some tricky question in the exam.
I would like to ask about my previous some exam question which I was failed.
(Not exactly but some I still remember)
Given net cash flow $9500 for 5 years ,cost of capital 12%
Q1@ ask me to find investment if NPV $20000 (this amount not sure may be $2000 )
Q2@ ask me to find investment amount if IRR 18%...
Can you help me how to calculate?
Thanks,
Cynthia
For the first question, you first discount the 9,500 cash flows by multiplying by the 5 year annuity discount factor at 12%.
You then subtract 20,000 and this tells you what the initial investment will be.
For the second question, the IRR is the interest rate at which the NPV equals zero. So discount the 9,500 cash flows by multiplying by the 5 year annuity factor at 18%. The initial investment must equal the present value of the cash flows that you have just calculated.
(The reason you would not end up with your cash deficit is because when you receive the money each year you will be using to pay back some of the borrowing and so the interest will be a lot lower.)
https://anlac-symphony.com/biet-thu-lien-ke-shophouse-an-lac-green-symphony/
Still trying to get my head around this, having watched all the previous lectures and still not getting it, I think I am having the same misunderstanding as Elaine above.
What I don't understand is that, if we assume the interest would be received on cash (rather than payable on borrowing), it amounts to higher than the 110,000 on the project. Other than using the DF, I can't see how this positive NPV is logically earning more than if we simply earned interest on the cash, instead of the project, which would be £117,128.
My only guess is that this is due to the fact that the return amount say for year 1 is £20,000 which is then effectively freed up capital with further interest earning potential? So the overall benefit of the project would essentially be the £110,000, plus the potential interest earned on the receipts generated each year?
Are we therefore using the DF to determine how much is needed to invest today, to receive the £20,000 after 1 year? Surely the real opportunity cost is the actual interest on the £80k which amounts to more than the £110k? Unless the £20,000 after 1 year is then available for further interest?
To understand, I just need to clarify if we are assuming that the £20k earned after 1 year, and subsequent years earnings has future earning potential in addition to the £80K invested? So its a matter of receiving higher return on capital sooner (with additional earnings potential), than overall amount generated by project vs interest on the £80k?
Thanks so much, I find your videos really helpful!
Lou
Where r is the interest 10%= 0.1
And N is the period
= 10% + 3.78% ??????
I get totally different answers.....off the grid,please help!!
Add 3.78 to 10 and you get 13.78.
The difference between + 6,660 and - 2,160 is bigger and is 8,820.
This is standard arithmetic :-)
Initial cost - $300,000
Expected life – 5 years
Estimated scrap value – $20,000
Additional revenue from the project – $120,000 per year
Incremental cost of the project – $30,000 per year
Cost of capital – 10%
A) calculate the Net present Value of the project (to the nearest $)
Please answer this for me as i am bit confused about how to deal with incremental costs.
The word incremental means extra - so incremental costs are extra costs.
For the above question in the comment, do we take the additional revenue as the cash flows per year minus the extra cost?? because we are not provided with any other cash flows, and we do this using annuity table right??
Using an interest rate of 10% per year the net present value (NPV) of a project has been correctly calculated as $50. If the interest rate is increased by 1% the NPV of the project falls by $20.
What is the internal rate of return of the project?
11.7%
20.0%
7.5%
12.5%
You know that the NPV at 11% (10 + 1) is $30 (50 - 20).
Now you have two 'guesses' and you continue as I do in the example in my free lectures.
Thank you so much