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Chapter 8 practice questions – relevant cash flow for DCF

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.
Viewing 6 posts - 1 through 6 (of 6 total)
  • Author
    Posts
  • November 16, 2015 at 9:51 pm #283162
    yoli100
    Member
    • Topics: 2
    • Replies: 3
    • ☆

    Could I have the solution for question number 5 on the practice questions quiz? I cannot calculate the correct answer.
    Thanks

    November 17, 2015 at 7:32 am #283213
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51560
    • ☆☆☆☆☆

    The 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 #283424
    yoli100
    Member
    • Topics: 2
    • Replies: 3
    • ☆

    Hi 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
    Yolanda

    November 18, 2015 at 8:01 am #283465
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51560
    • ☆☆☆☆☆

    Because 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 #284263
    yoli100
    Member
    • Topics: 2
    • Replies: 3
    • ☆

    Thanks very much

    November 21, 2015 at 8:59 am #284286
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51560
    • ☆☆☆☆☆

    You are welcome 🙂

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