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Hi John
Could you please explain how they arrived at the terminal value of 8,195,309
(6.2m*1.08^6)-1.2m gives 8,638,621..
The value of the building is increasing at 8% per annum in real terms. Since the general rate of inflation is 2.5%, the actual rate of increase in the value is (1.025 x 1.08) – 1 = 10.7%
Because the building is taking 12 months to build, the value will inflate for 5 years, not 6.So the terminal value = 6.2M x 1.107^5 = 10,306,941
The charge for repair and renewals is given at current prices, so the actual/nominal cost is 1.2M x 1.025^6 = 1,391,632
So the net cash flow = 10,306,941 – 1,391,632 = 8,915,309 (which is the figure in the answer – you accidentally mistyped it in your posting).
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