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Hello John,
I want to seek your advice on below topics inflations –
1. Fernhurst Co expects to sell 132,500 units of the Milland in its first year. Sales volume is expected to increase by 20% in Year 2 and 30% in Year 3, and then be the same in Year 4 as Year 3, as the product reaches the end of its useful life. The initial selling price in Year 1 is expected to be $100 per unit, before increasing with the rate of inflation annually.
2. Fernhurst Co will also need to make an immediate investment of $1,025,000 in working capital. The working capital will be increased annually at the start of each of Years 2 to 4 by the inflation rate and is fully recoverable at the end of the project’s life.
Query: 1. Selling price for year 1 was not inflated in the answer though the words look like we need to inflate from year 1. Please help me to understand it correctly.
Query 2: Working capital was inflated from year 1, but my understanding from the above is that we need to consider the inflation from year 2. Need to know better on how to link these wordings to the context.
If you have already covered this question in the past, happy to have the link to avoid duplication.
I have been following your lectures and was be to clear PM & FM. Thanks for your videos 🙂
Regards,
Madhu1. The question says that the selling price is expected to be $100 in year 1 (so the actual revenue at time 1 will be $100 per unit) and that it will increase in subsequent years (so the revenue at time 2 will be inflated).
2. The first working capital is needed at time 0 (which is the start of the first year). It will be increased at the start of the second year (and onwards) and the start of the second year is 1 year from now and is time 1.
(Always, time 0 is the start of the first year; time 1 is the end of the first year/start of the second year; time 2 is the end of the second year/start of the third year; and so on. They are points in time that are 1 year apart.)
Hello Mr John,
Thank you Madhuap. I also had the same understanding your stated.
@Mr John, thank you for your teachings and time. I’m still not clear on the Time 0 is the start of the 1st year. What is then the difference between time 0 & time 1 please if they are both the start of the 1st year.
What video can I watch to really explain the Time 0, year 1 concept to me.
Thank you sir,
The times are points in time that are 1 year apart.
As I wrote in the last sentence of my previous reply, time 0 is ‘now’ and is the start of the first year. Time 1 is one year from now and so is the end of the first year / start of the second year. Time 2 is 2 years from now and so is the end of the second year / start of the third year. And so on.
This is all explained in the Paper FM lectures on Investment Appraisal (because this is revision from Paper FM and is the basis of all the discounting).
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