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- August 23, 2018 at 10:54 am #469066
hi

i would really appreciate some confirmation.

please see the question below (its from a finance book)

ABC Ltd. uses a time horizon of 12 years to forecast free cash flows.

They use a planning horizon of 3 years after which they expect cash flows to remain at a

steady level.The cash flows projected are as follows: 3m in year 1, 5m in year 2 and 7m in year 3

The stock market value of debt is $6m and the cost of capital is 10%.Calculate the value of the firm?

now i understand how to solve this but i am pretty sure they made a mistake in the book answer.

they first discounted cash flows of 3m, 5m and 7m in years 1,2 and 3 by 10% and used annuity for years 4 to 8

in years 4 to 8 they assumed the cash flow to be 7m and they multiplied this 7 by annuity of 11 years minus annuity of 3 years

however this is wrong since they should have used annuity of 12 years minus annuity of 3 years multiply by 7

it must be 12 not 11

am i right? since the project is for 12 years?

please let me know

thanks

August 23, 2018 at 5:12 pm #469115Apart from the fact that you typed ‘years 4 to 8’ twice, which makes no sense, what you have written is correct.

The annuity is from years 4 to 12, and so they should take the 12 year annuity factor and subtract the 3 year annuity factor.

Alternatively, (as you should remember from my Paper F2 and F9 lectures) you could take the 9 year annuity factory (because there are 9 years of flows) and multiply by the 3 year ordinary present value factor (because the annuity starts 3 years late – at time 4 instead of time 1).

Both ways would give the same result (apart from roundings, which are irrelevant for Paper AFM).I don’t know which book you are referring to, but you really should be using a Revision Kit from one of the ACCA approved publishers.

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