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March 19, 2020 at 11:08 am #565417pajankan
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I am struggling to understand (being a non-native speaker) what is meant by ‘in one year’s time’ when discussing future cash flows in a NPV valuation.
The lecture example from my notes says: ‘The theme park would cost a total of $400m and could be constructed and working in one year’s time. Half of the £400m would be payable immediately, and half in one year’s time.’
In the solution, ($200m) is included in Year 0, the other ($200m) in Year 1 but the Revenue from admission tickets only starts in Year 2. Both the other half of the initial £400m investment and the theme park being fully operating are ‘in one year’s time’ but for some reason one is in Year 1 and the other in Year 2?
The full question reads: ‘Sleepon Hotels Inc owns a successful chain of hotels. The company is considering diversifying its activities through the construction of a theme park. The theme park would have a mixture of family activities and adventure rides. Sleepon has just spent $230,000 on market research into the theme park, and is encouraged by the findings. The theme park is expected to attract an average of 15,000 visitors per day for at least four years, after which major new investment would be required in order to maintain demand. The price of admission to the theme park is expected to be $18 per adult and $10 per child. 60% of visitors are forecast to be children. In addition to admission revenues, it is expected that the average visitor will spend $8 on food and drinks, (of which 30% is profit), and $5 on gifts and souvenirs, (of which 40% is profit). The park would open for 360 days per year. All costs and receipts (excluding maintenance and construction costs and the realisable value) are shown at current prices; the company expects all costs and receipts to rise by 3% per year from current values. The theme park would cost a total of $400 million and could be constructed and working in one year’s time. Half of the $400 million would be payable immediately, and half in one year’s time. In addition working capital of $ million will be required from the end of year one. The after tax realisable value of non-current assets is expected to be between $250 million and $300 million after four years of operation. Maintenance costs (excluding labour) are expected to be $15 million in the first year of operation, increasing by $4 million per year thereafter. Annual insurance costs are $2 million, and the company would apportion $2. million per year to the theme park from existing overheads. The theme park would require 1,500 staff costing a total of $40 million per annum (at current prices). Sleepon will use the existing advertising campaigns for its hotels to also advertise the theme park. This will save approximately $2 million per year in advertising expenses. ‘
Thank you in advance!
PatrykMarch 19, 2020 at 6:34 pm #565441John MoffatKeymaster
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0, 1, 2 etc are not really years but are points in time that are 1 year apart.
As far as the cost of $400M is concerned, the timing of the two payments should be clear.
However as far as operating flows (i.e. the revenue and the running costs) are concerned, we always assume (unless specifically told differently) that the flows occur at the ends of years.
So….any flows in the first year will occur in 1 years time, i.e. time 1.
Any flows in the second year will occur in 2 years time, i.e. time 2.
and so on.
In this question, since the park only starts operating in 1 years time, the first revenues will occur in the second year. They are assumed to be at the end of the second year which is 2 years from now and therefore time 2.
It may help you to watch my free Paper FM lectures on investment appraisal, because this is revision from Paper FM.September 16, 2022 at 8:36 am #666532peixin1028
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Hi, This is the sentences I don’t understand.
The theme park would require 1,500 staff costing a total of $40 million per annum (at current prices).
May I know what is this meaning?? And why the labour cost is not 40 million per year?? Also why the insurance will increase every year??
Thanks in advance.September 16, 2022 at 2:42 pm #666540John MoffatKeymaster
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The question says that all costs and receipts will rise by 3% per year. ‘Current prices’ are the amount before any inflation.
It may help you to watch the free Paper FM lectures on ‘investment appraisal with inflation’ because this is revision from Paper FM.
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