- This topic has 10 replies, 2 voices, and was last updated 8 years ago by
.
- Posts
- Topics: 2
- Replies: 12
- ☆
How do we know if the flow is real or actual and if the cost of cap given is real or actual?
The question says quite clearly that the cash flows are at current prices, and therefore they are the real cash flows and need inflating to get the nominal (actual) cash flows.
The cost of capital is always the nominal (actual) cost of capital unless you are specifically told otherwise.
Have you watched the free lectures on this? The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
- Topics: 2
- Replies: 12
- ☆
Q, Earnings 5000 p.a at current prices in perpetuity.inflating at 4% p.a.
The cost of capital is 12&.
What is the p.v of the receipts?Ans. So from what i understand from your reply and from the answer of that mcq is that:
1. Current price means real price terms
2. If cashflows are at current price it means they r real cashflows so we have to convert the cost of cap into real/effective cost of cap first and then calculate npv
3.cost of capital like in the question above will always be actual/nominal cost of capital , and it will be specifically mentioned in case the cost of capital is real/effective.Am i correct sir?
You can either discount the real cash flows at the real cost of capital (which means calculating the real cost of capital), or alternatively (and more sensible here) you can calculate the nominal cash flows by inflating them at 4% per year and then discount them at the actual (nominal) cost of capital of 10%.
I explain this in my lectures (you have not answered my question as to whether or not you have watched them 🙂 ).The exam questions always make it clear whether the cash flows are the actual cash flows or the current price flows, and also whether the cost of capital is the actual or the real cost of capital.
Again – do watch my free lectures!
- Topics: 2
- Replies: 12
- ☆
Yes sir i m watching your lectures n they are helping alot 🙂
I tried inflating $5000 but that way i don’t get that $65000 answer :s- Topics: 2
- Replies: 12
- ☆
Cost of capital given is 12% in the question and as nothing is written about it so it means its actual/nominal cost of capital.
- Topics: 2
- Replies: 12
- ☆
One off topic question. When u said i don’t need the study text if i watch ur lectures and read ur lecture notes,does that apply to the whole of f9?
Sorry – I made a mistake in my previous answer to you 🙁
There are the two ways of dealing with inflation as I wrote, and although usually it is more sensible to inflate the cash flows and then discount at the actual (nominal) costs of capital.
However, because this is a perpetuity it is impossible to inflate the cash flows in perpetuity and so this is the one time that there is no choice but to discount the current price flow (ignoring inflation) at the real cost of capital.Using the Fisher formula (from the formula sheet in the exam), the real costs of capital (r) is calculating from 1+r = 1.12/1.04 = 1.076923077
So r = 0.076923077 (or 7.6923077%)The discount factor for a perpetuity is 1/r, so the present value is 5,000 x 1/0.076923077 = 65,000.
In answer to your other questions, yes – the cost of capital given in the question is always the actual/nominal cost of capital unless the question says different.
And yes, the free lectures cover everything needed for F9 and so you don’t really need a Study Text. You do need a Revision Kit, because they contain lots of questions for practice and practice on exam standard questions is vital to passing the exam.
If you come across anything in the lectures or in your Revision Kit that you are not clear about, then ask in this forum and I will explain.
- Topics: 2
- Replies: 12
- ☆
Thankyou so much sir , you are awesome ???
- Topics: 2
- Replies: 12
- ☆
Umm there were emoticons instead of “???” At the end of previous post :p
Thank you 🙂
- The topic ‘Chap 8, mcq 2’ is closed to new replies.