Investment Appraisal

This topic has 3 replies, 3 voices, and was last updated 4 years ago by John Moffat.

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September 2, 2020 at 5:58 pm #583156
james8500
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An investment of $120,000 on 1 April 20X6 is forecast to yield a net cash flow of $14,000 each year for four years commencing on 31 March 20X7, followed by $20,000 each year in perpetuity. The appropriate cost of capital is 8% per year.
What is the positive net present value of the investment (to the nearest $1,000)?
Answer is 93,000.
Can you please explain this? As I understand it:
(120,000)
1-4 14,000*3.312 46,368
Perp. (20,000/0.08)*0.735 110,000
My Answer – 110,118. <<110,000 to nearest ‘000
Thank you!
September 3, 2020 at 9:33 am #583210
John Moffat
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Either you have mistyped the question or there is an error in your book.
Your workings are correct (although you have mistyped one of the figures).
(20,000/0.08) x 0.735 = 183,750 (not 110,000).
46,368 + 183,750 – 120,000 = 110,118.
September 3, 2020 at 5:14 pm #583286
nbhutia
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Hi
I believe its 14000x df which is 3.993-1st year df 0.926= df of 3.067
14000* 3.067= £42938
20000/0.08x df 0.681= 170250
42938+170250-120000= 93188 approx 93000
20,000 perpetuity starts in year 5 I believe.
year 2-5 less yr 1 annuity
September 4, 2020 at 9:22 am #583355
John Moffat
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nbhutia:
No. The first 14,000 is in 1 years time and so the annuity is 1 – 4.
The 20,000 perpetuity starts at time 5. So it is discounted using 1/0.08 and then discounted using the normal 4 year discount factor because it starts at time 5 instead of time 1.
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