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Hi Mr John,
Can you please help me understand following for BPP KIT Q. 74 Blipton International Part a-i :
1- In this question, we need to calculate separate investment phase nominal dollar cashflows and return phase nominal dollar cash flows. To calculate investment phase cashflows, capital allowance has been added in there rather than return phase. Can you please explain why? Also tax is arising starting 20X5, then why are we taking capital allowance starting from 20X4? Is this because of the FYA of 50% on £6.2 million?
2- We calculate 1/1.4925= 0.67 ( $1.4925/£). This is to make Dollar base case and Sterling foreign case.
As in now we see it to be £0.67/$ because according to the information in question £ seems to be the base currency and $ seems to be foreign but the requirements asks us to calculate $ cashflows? Is this what inversing the spot rate is?3- This must be a very silly question but I need to reassure myself. When we are converting weak currency into strong currency, we divide. When we are converting strong currency into weak currency, we multiply like we did in this question when we are converting £ nominal cashflows into $ cashflows. Am I thinking it right?
4- Timing in this question, 20X3 is time 0 and 20X4 is time 1. Is it because right now in the question it is 1 December 20X3, so it is current year and after 31 December 20X3, year 20X4 begins. I confused 20X4 to be time 0.
I know these must be really silly questions but I need to clear my confusion as these small points really are my nightmare hahah. Thank you. Have a good weekend :).
Kanza
1 The capital allowance savings are as a result of the capital investment (and are not actually receipts anyway – they are reductions in the tax that would otherwise be payable)
Yes -because of the FYA2 The question says that 1.4925 $’s are equal to 1 GBP. $’s are the base currency because Blipton is in Dubai and all they work in $’s.
3. Whether you multiply or divide to convert depends on whether you are converting from $’s to GBP’s or the other way round – not because one currency is weaker or stronger.
4 Time 0, time 1 etc are not years – they are points in time that are one year apart.
Time 0 is the start of the first year. Time 1 is one year later – i.e. the end of the first year/start of the second year, and so on.Thank you for your quick reply. I appreciate that a lot. 🙂
For No. 3, can you please elaborate.
What I understand is if the currency of the amount we are converting and the exchange rate given are in the same currency, we divide. As here when converting £ cashflows into $, we divide them and so on, where 1 $= £0.67. So for year 20X5, we divide £38.24 m with £ 0.6408 and get $59.68 m.
But if we, for example, had a conversion rate like $1.4925/£, to convert £ cashflows into $, we will multiply them by $1.4925 because currency of cashflow and exchange rate is different?
If the exchange rate is given as GBP/$ 0.67, then it means that 1 $ is equal to GBP 0.67.
So when converting GBP to $’s you need to divide by 0.67If on the other hand it is given as $/GBP 1.4925, then it means that 1 GBP is equal to 1.4925 USD and so when converting GBP to $’s you need to multiply by 1.4925.
It does not matter which you do because they would both give the same answer (subject to the rounding – the precise equivalent of 0.67 is 1/0.67 which is 1.4925373. Rounding does not matter in the exam)
The first bit of the first free lecture on foreign exchange risk management revises from F9 the way that we use exchange rates to convert, and I think you will find it useful.
Hi, could you please explain how the nominal cash flow was calculated. I got the same nominal rate as per BBP Kit at 9.2%, however when I multiply year 2 (20X5) real cash flow of £52 by 1.092 I get 56.78 and not 54.63 per the Revision Kit. Thanks.
9.2% – the actual (nominal) cost of capital is not relevant for arriving at the actual (nominal) cash flows. It is only relevant when we come to discount.
The flow of 52 is at current prices (i.e. the real cash flow) and is subject to inflation at 2.5%.
Therefore the nominal (actual) cash flow is 52 x (1.025^2) = 54.63
(The free lectures will help you with this)
Hi Mr John,
Could you please explain the repairs and renewals 1.2million in current price need to inflate by 2.5%? I don’t understand why the terminal value of hotel in BPP answer is different with dec2008 exam answer sheet. How to get the amount of 8,915,309 terminal value of property in exam answer sheet? Thank you.The BPP answer is not correct.
The construction cost was 6.2M. Property prices are inflating by 8% in real terms and so since general inflation is 2.5% it means that the actual inflation in money terms is (1.08 x 1.025) – 1 = 0.107 (or 10.7%).
So the value after 5 years will be 6.2M x (1.107^5) = 10,306,941The charge for repairs and renewals is 1.2M at current prices. There is general inflation at 2.5%, and so the actual money cost is 1.2M x (1.025^6) = 1,391,632
So the net cash inflow is 10,306,941 – 1,391,632 = 8,915,309
Sir,
Why is that the Revenue/contribution & fixed cost is not inflated by the inflation cost of 2.5%?
Thanks
But they have been inflated by 2.5% per annum!!
The first contribution and fixed costs are at time 2 and are 52 at current prices.
They have then been inflated by 2.5% for 2 years to give a nominal cash flow of 52 x 1.025^2 = 54.63. The same for future years.Since both are inflating the same rate it is quicker to inflate the net flow rather than inflate each one separately.
Hi John,
In blipton international, how to calculate the residual value of the investment?
I know you have answered this question above but I still don’t get it.I cannot really add much to what I typed before!
If something is inflating in real terms, it means that it is inflating more than the general rate of inflation.
General inflation is 2.5% p.a., but since this is inflating at 8% in real terms it means that the actual cash amount will be higher by 2.5% and by 8% as well.Thank you.But I don’t understand why the open market value is 6.2*(1.08*1.025)^5? Why is the power 5?
And why is the charge for repairs and renewals power 6?The building is finished in 1 years time. It is sold in 6 years time. So there is 5 years between the two.
The repairs and renewals are given at current prices and therefore automatically after 6 years there will have been 6 years inflation.
(For the benefit of anyone reading this who is looking at the question in the BPP Revision Kit, they have changed the wording. In the original exam question it said that the repairs and renewals are given at current prices. BPP have changed it to ‘money terms’ (which means it would not need inflating))
The examiners answer does show an outflow of 6.2M at time 1 (31 December 2009). It is the very first line on the list of the cash flows.
Dear Sir,
To Arrive at the Nominal Discount rate, the Inflation rate used is that of USD 4.8%.
Where as the Cash flows are already converted to Pounds before the discounting is applied. So is it not right to have used the Inflation rate of Pounds (2.5%) to arrive at the Discount rate : (1+0.042)x(1+.025)-1 ?
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