Cash Flow Timing for Fuelit Plc — OpenTuition Forums

Nnikita0213y ago

Hi Sir, I seem to be confused as it relate to determinig the timing of Cash Flows in general. I thought i understood it when i did F9. Can you please explain the rules for me. More specifically, I was trying to work out how it was determined that cash flows would start in year 4.

John MoffatTutor13y ago#1

It is hard to write it as a general rule, but if I explain what is happening in Fuelit, then it should help. Before I do, remember the time 0, time 1 and so on are points in time - they are not years. So....the first year starts now (time 0) and it end in a years time (time 1). (OK it may be one day less that a year, but for discounting, which is obviously what we are doing, we are not worried about one or two days :-) ) Similarly, the second year starts in one years time (time 1) and finishes in two years time (time 2). The reason this is important is that (unless you are told different) we always assume that the operating cash flows (revenue, matieral costs etc) occur at the ends of years. So.....the first years revenue is at time 1 etc.. In Fuelit, it says in note 1, the electricity generation will commence is three year. That means that we start generating in 3 years time (time 3) BUT the operating flows for that year will occur at the end of the year which means they first start in 4 years time (time 4). I hope that makes sense :-)

Nnikita0213y ago#2

Thanks a mil. This explaination makes every thing so clear now.

John MoffatTutor13y ago#3

You are welcome :-)

Wwlta10y ago#4

Hi Mr.John, Can you kindly answer me in this question, why they assume that WACC is a nominal rate and turn it into real rate. Thank you.

John MoffatTutor10y ago#5

The nominal cost of capital is the actual cost of capital - it is not an assumption. The cost of capital in this question is calculated in the normal way and is therefore the actual or nominal cost of capital. Usually we discount the nominal (actual) cash flows (after inflating them) at the nominal (actual cost of capital). However, since here all flows are inflating at the same rate (and over a very long period which would make it ridiculous to be inflating the cash flows for 28 years!), we can get the same result by discounting the current price flows (ignoring inflation) but the real cost of capital (which is the nominal cost of capital with the inflation removed, using the fisher formula). I do suggest that you watch the Paper F9 lectures on investment appraisal with inflation where the real (or effective) rate, and when to use it, is explained towards the end of that chapter.