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Hi tutor,
For project 5 cash flows, 15 year annuity was taken and discounted at year 3. However the cash flow inflow started from year 4-15. As per ur lecture on annuity you have said that , for inflows to be started for eg after year 3. Annuity for 3 years should be deducted from total annuity rate. I am really confused here as 15 year annuity doesn’t seem logical even discounting it at year 3.I discounted the project 5 cash flows for year 4 — 15 like this.
Cash flows : $970000
Annuity for 15 years : 7.19
Less annuity for 1-3 years : 2.44I.e 7.19-2.44= 4.75
Present value ( 4-15 years inflows ) : 970000×4.75= 4607500
Present value of investments ( year 1-3 ) : 4718000
Npv : 4718000-4607500=negative npv of : (110,500)
Please help me out.
You have misread the question.
There is an annuity of 15 years, but it starts at time 4. So the flows are actually from 4 to 18 (inclusive)
You can get the discount factor either of two ways:
One way is to take the 19 year annuity factor and subtract the 3 year annuity factor – that will leave you with 4 to 19.
The other way is to take the 15 year annuity factor, but then to multiply by the ordinary 3 year discount factor (because the annuity starts 3 years late – time 4 instead of time 1)
Either way will always give the same answer (there may be a tiny rounding difference because the tables are only to 3 decimal places, but that does not matter in the exam).
You are obviously more happy with the first way, so stick with that way. It is just that since the tables only go up to 15 years, doing it the first way does mean calculating the 19 year annuity factor yourself using the formula at the top of the annuity factors page.
Hi John,
Can we take PV of 11% for 3 years and multiply by AF of 11% for 12 years (just like in Mlima co June 2013)? 12years is 15 years – 3 years.
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