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Dear sir,
I have question on examer’s answer regarding the calculation of value of Ndege.
In examiner’s answer :
Add: present value of cash flows from year 2 onwards:
($9·14m x 1·052)/(0·1 – 0·052) x 0.909=182·11mWhy calculate the year 2’s PV still using year 1’s discount factor? Why not using 0.826 here?
Thank you
Dear Faniacca,
There reason is very simple. May be the Free Cash Flow from year 2 will increase by 5.2% into infinity and the the cost of capital is 10. There to get the value of the cash flow now the Free Cash Flow at year 2 will grow at 5.2% and you divide it by the cost of capital less the growth (5.2%) and multiply by the discount at the base year. In the question above the base year is year one.
This is you can understand from the valuation of share price with the growth from your F9.
Thanks and best regards.
Elomi, MT.
Of course I know the share growth model. That is not my question. The year 1cash flow is discounted by 1 year discount factor which is 0.909. But why year 2 still using the I year discount factor 0.909. Discount that terminal value to present time shouldn’t it use 0.826.
Thanks for your reply, but you don’t get what I mean.
faniacca:
If you wish for me to answer then you should post in the P4 Ask the Tutor Forum – this forum is for students to help each other.
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