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While calculating the value of Machinery Parts business, the examiner did :-
CF * (1+g) / Cost of Capital.
Doesnt this give us the value of company at year 1? Why wasnt it discounted to Present Value?Also why is 1800m subtracted from the Value of Shipping Business when the question says that the new capital structure would be 20:80? For the Equity Value, shouldn’t the value straight away be multiplied by 80%?
Hi!
Will leave my question here since it is the same question number. Hope that’s alright.-Machinery unit: Management buy out-
In this part, the question stated that the ‘after tax profit will grow by 8% for the first year only, and will remain at this level for foreseeable future.’
In that case, I assumed that it meant:
After tax profit
Y0: $435m
Y1: $470 (108% of Y1)
Y2 onwards: Maintain at $470The answer for this part is 435(1.08)/0.1= 4698m (value of machinery unit)
I do not understand 3 parts of this:
1. Why is it that the question stated ‘the 8% growth is for only for first year, and no growth for foreseeable future’, but the answers assumed the ‘g’ to be 8%? In my understanding, having g = 8% implies that the cashflow will grow infinitely at 8%, which was not what the question stated.2. Why is it that in the printed answer, they did not deduct the growth rate of 8% in the denominator? (Under usual circumstances it’d have been 435(1.08)/(0.1-0.08), but in the answer they did 435(1.08)/0.1).
3. I also don’t understand why they immediately took Y0 cashflow ($435m) to calculate.
Usually, we would find the value by (Y0)+(Y1 discounted)+(Y2 grow at perpetuity) = value of business unit, which will be $470(1.08)/(0.1-0.08).I hope I didn’t phrase it too confusing! Thank you in advance.
Another doubt I developed while going through the answer is, are we making the SOFP and SOPL just after the restructuring or 1 year after?
Bcs in the answer, we have added the value of 1200m (Additional equipment) in Current Assets, and depreciated the “Additional Equipment” while making the SOPL (that gives a hint that we’re making a forecast of SOFP and SOPL).
But in the SOPL, we’ve taken the past year figures of Sales Revenue and Operational costs. I’m confused over this. How can we use past year Sales Revenue while forecasting for next year?The flow in perpetuity is a constant $470 per annum (8% higher than $435).
The discount factor for a constant perpetuity in 1/r (as in Paper MA and Paper FM!).
Therefore the PV of 470 p.a. in perpetuity is 470/0.1
This is not a growing perpetuity (i.e. growing each year). The question makes it very clear indeed that the only growth is in the first year and that there is no more growth thereafter.
The statements are showing the effect immediately after the restructuring takes place.
If they are being made just after the restructuring, then why has the examiner depreciated the new machinery?
In the extract of the SOFP the new machinery has not been depreciated – it appears at its cost of $1,200m.
When looking at future flows for the purpose of estimating a value, then future depreciation is relevant.
Alright sir, got it. How can I not confuse myself in understanding that the SOPL and SOFP are to be made immediately or after one year? I’ve did the same mistake in a lot of questions!
Also, about the perpetuity formula.
Sir when we have calculated the perpetuity, we took the CFs year 1 onwards. Then why haven’t we discounted the obtained value to Present Value?As to whether the statements are immediate or after one year depends on the wording – I am afraid that I cannot give you an easy rule. But don’t panic because if you read wrong you should be still able to be getting more than the 50% of the marks needed.
Multiplying by 1/r gives the PV of a perpetuity where the first flow is in 1 years time.
Alternatively, use the growth formula with g equal to 0 when there is zero growth – it is the same thing.
If you watch my lectures working through chapter 15 of our Paper FM lectures notes, then I work through several examples of unusual dividend streams.
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