Forums › ACCA Forums › ACCA FM Financial Management Forums › Chapter 8 practice questions – relevant cash flow for DCF

- This topic has 5 replies, 2 voices, and was last updated 7 years ago by John Moffat.

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- November 16, 2015 at 9:51 pm #283162
Could I have the solution for question number 5 on the practice questions quiz? I cannot calculate the correct answer.

ThanksNovember 17, 2015 at 7:32 am #283213The questions appear in a random order – question 5 will not always appear as question 5 – so please give me a clue as to which question you are asking about and then I will help you.

November 17, 2015 at 9:44 pm #283424Hi John,

The question is:

A project is expected to earn $5,000 per year (at current prices) in perpetuity, inflating at 4% per year. The first receipt will be in one years time.

The cost of capital is 12%

What is the present value of the receipts ( to the nearest $100)Answers are:

$62,500, 58,000, 41,700, 65,000

I get 41,700 with my calculations but this is not the correct answer

I think I am applying incorrectly the perpetuity discount factor?

Thanks

YolandaNovember 18, 2015 at 8:01 am #283465Because it is an inflating perpetuity you have to discount the current price flow (5,000 per year) at the real (or effective) discount rate.

The real rate = 1.12/1.04 – 1 = 0.076923 (or 7.6923%)

Discounting the perpetuity at this rate gives: 5,000 / 0.076923 = 65,000

(Alternatively you can use the dividend valuation formula – it works for any inflating perpetuity (not only dividends).

So PV = (5,000 x 1.04) / (0.12 – 0.04) = 65,000 )

November 21, 2015 at 7:14 am #284263Thanks very much

November 21, 2015 at 8:59 am #284286You are welcome 🙂

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