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Does anyone know why the annuity of let say 3 years time in the future when discount back to the present always use the discount rate of 2 years time ahead?
I thought it supposed to use the 3 year discount rate
for example
let say annuity of 4 years is dividend/ ke -g = 2325 ( example at page 348 in bpp book)
when discount back to the present it uses the rate of 14% of 3 years which is 0.675
Can someone helps me plz?You are confusing two things together.
Firstly, when we have an annuity and we multiply the flow by the annuity factor it is assuming that the first flow is in 1 years time and the result is the PV now – time 0.
If the annuity starts in 3 years time, this means it starts 2 years later than in 1 years time, and therefore the result is a PV two years later – which is therefore at time 2 instead of time 0. We therefore then need to discount for 2 years to get the PV now.Secondly, when we use the dividend growth formula it is giving the PV of an inflating perpetuity (not an annuity), but the same principle applies. If the first dividend is in 1 years time, then the formula gives a PV now, time 0. If the first dividend is in 3 years time (so it starts 2 years later than in 1 years time) then the formula gives a PV two years later than now and so needs to be then discounted for 2 years.
I do suggest that you watch my free lectures. The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
(If you want me to answer any future questions, then please ask in the Ask the Tutor Forum – this forum is for students to help each other 🙂 )
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