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Hi John,
1) I don’t understand why the answer to this question starts a year earlier(2003) rather then 2004 which is the year of construction.
I see the question says “all cash flows including construction costs are assumed to arise at the end of the year concerned”
What that statement means to me is that if something is at the end of the year it should start at the start of the next year? so the construction costs in 2004 started in 2005(from what i remembered from f9 cash-flow timing)
2) Why is capital allowance taken in the same year of construction, shouldn’t it usually be the first year after?
Thanks in advance
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Please ignore question 1 i see where is says it is now dec 2003.
but clarification on the below two please:
1)What does it mean when they say “all cash flows including construction costs are assumed to arise at the end of the year concerned”
What that statement means to me is that if something is at the end of the year it should start at the start of the next year? so the construction costs in 2004 started in 2005(from what i remembered from f9 cash-flow timing)
2) Why is capital allowance taken in the same year of construction, shouldn’t it usually be the first year after?
1. We normally do assume that cash flows arise at the end of the year.
So a flow in the first year is assumed to be at the end of the first year, which is time 1 (i.e. one year from now).
Had it been occurred at the start of the first year, then it would be at time 0 (i.e. now).Similarly a flow in the second year, if assumed to be at the end of the year, would be in two years time (i.e. time 2). Had it occurred at the start of the second year then it would be in one years time (i.e. time 1)
2. It is an assumption and you could have assumed either (even though it gives a different answer). The important thing is P4 is to always state your assumptions because so much (certainly in Question 1 of the exam) depends on your assumptions.
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Perfect, so regarding the timing of the cashflows why haven’t they implemented that in the answer so for example the construction cost in 2004 it should have been 2005? and then a domino affect on the rest of the cashflows
They have implanted it as per the details in the question!
The initial cost of an investment is usually assumed to be at the start of the first year (time 0).
However because here the construction is during 2004, and the question says that construction costs are assumed to be at the end of the year, then the cash outflow will occur at the end of 2004, which is time 1.
The cash flows at time 1 have then been discounted for 1 year which is obviously correct
🙂
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