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The following is an extract taken from question 45 of AFM Kaplan Exam kit of 2018-19 edition which says:
“The finance director would also like some simple analysis based on the possibility that the marketing expenditure is not effective and the launch fails as he feels that the product price may be too high. He suggested that there is a 15% chance that the Mililand will have negative net cash flows for year 1 of $ 1M or more. He would like to know by what percentage the SP could be reduced or increased to result in the investment having a zero NPV assuming demand remained the constant.”
Sir, in the suggested answer they calculated the sensitivity analysis @ 18%. How do they arrive at this number?
Also in the same question, there was a calculation of Macaulay duration which i calculated right but the explanation of the same was confusing as it has been written in the answer that “it took 2.78 years to recover the half of the PV of cash flow” what does this line mean?
Waiting for your reply
RegardsI do not have the Kaplan Exam Kit, only the BPP Revision Kit. If it is marked as a past exam question then tell me the name and the exam because I do have all past exam questions.
As I explain in my free notes and the free lectures that go with them, it is a standard feature of the Macauley duration that it gives an approximate period to recover half of the flows (the same sort of idea as the discounted payback period).
Sir also need your advice i have both kaplan & bpp exam kits.Should i cover both books or any one of them & which one would be better from exam’s point of view considering i am appearing for 3 p level papers in June 2021?
Thanks & Regards
In the same way as explained in my Paper FM lectures, the sensitivity is the NPV divided by the PV of the flows that will change.
For every $1 fall in revenue, the profit will fall by $1 and therefore the net cash flow would fall by $0.75 (because of tax), and so the NPV would fall by the PV of the revenues x 75%.
We need the NPV to fall by $7,801 to get to zero.
The PV of the after tax revenues is $43,441
So the PV of the revenues needs to fall by 7,801/43,441 = 18%, and so the revenues need to fall by 18%.
If you are still unsure, then look back at my free Paper FM (was F9) lectures on ‘Investment appraisal under uncertainty’, explaining sensitivity analysis.
yes i did watched your f9 lecture on sensitivity analysis besides your AFM lectures, my only confusion was regarding why they have deducted tax from revenue. Isn’t tax deducted from profit portion? Anyways thanks for clarifying
Regards
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