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Hi Chris
I hope you are well.
https://www.youtube.com/watch?v=Yl4WxKaO4UY&ab_channel=OpenTuition
I’ve got a few questions relating to the above lecture video and Example 1 in particular. When it comes to impairment questions, do we always ignore the cost of capital figure as I can’t see that we’ve used it in this example.
Also, with regard to the value in use, is the annuity factor reflecting the 5 year period of the cash flows? I only ask as I can’t understand why we didn’t do 5000 x 5 years if that’s not the case. Thanks in advance.
Kind regards
James
Hi James,
The cost of capital figure will be used in calculating the value in use when we look at the present value of the cash flows from using the asset. So would be taking the 5,000 inflows and applying an annuity factor for five years at the cost of capital given in the question.
Thanks
Hi Chris
OK, thanks for that. In that case, why didn’t we use the cost of capital in Example 1 for the value in use calculation?
On a side note, with Example 1, why didn’t we do £5000 x 5 years x the annuity factor for the value in use part? Is the value in use only based on the 1 year we are doing the financial statements for?
Thanks in advance and apologies for so many questions.
Kind regards
James
Hi,
We didn’t need to use it as we had been given the annuity factor for 5 years at the 10% cost of capital. To get the value in use we then take the 5,000 cash flow and multiply by the given annuity factor.
Thanks
Hi Chris
I’m really sorry but I’m not understanding your 1st sentence. Can you possibly explain this further? I think I understand your 2nd sentence however. Is the annuity factor essentially discount factor? Or is there a difference? I’m really sorry about this. Thank you.
Hi James,
An annuity factor is applied to the cashflow where we have a series of constant annual cashflows. It is effectively just the sum of the discount factors for each of the years of the cashflows. So, a discount factor for one year at 10% is 0.909 and for two years is 0.826.
The two year annuity factor is 1.735 being the sum of 0.909 and 0.826.
If the cashflow was 5,000 each year for two years (i.e. constant) then we could either:
5,000 x 0.909 + 5,000 x 0.826 = 8,677
Or,
5,000 x 1.735 = 8,677
Thanks
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