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ACB Co is appraising a project with an initial investment of $1 million that will generate net cash inflows AFTER TAX of $150,000 per annum indefinately. ACB Co estimates its cost of capital to be 12%.
What is ACB’s percentage sensitivity to their estimate of a 12% cost of capital?Sir, in answers it says (150000/IRR) – 1000,000=0. IRR=15% so sensitivity= 15-12/12=25%. But its not our method with you though seems logical.
According to our method we calculate IRR (at 12% and at 20% ive chosen):
Its exactly 16%. so 16-12/12=33.33% sensitivity of Cost of capital.Please 1)comment why is answer different 2)what’s the relevance of net flows giving “AFTER TAX.” (we always discount after tax isnt it?)
Thank you!!
The approach is exactly the same in both cases.
The difference is due to the fact that you have calculated the IRR wrongly!!If it is a perpetuity then you don’t need to make two guesses – you can calculate the IRR precisely because you know that the PV of a perpetuity is the cash flow multiplied by 1/r.
Since you know the PV needed for a NPV of zero (it must be equal to the original cost), and you know the annual cash flow, you can calculate the IRR exactly.(Just try calculating the NPV at 16% – it only takes a second – and you will see that it is certainly not equal to zero!)
Yes – we always discount the after tax flows when appraising investments.
so when its only perpetuity we dont need 2 IRRs at 2 different DF’s. Just NPV/IRR – initial investment=0 and calculate IRR from equation.
Thats right?
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