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Hi Sir, I would like to ask:
1) How do you determine the cashflow’s periods, shouldn’t the operating surplus be yr 1 figure and the whole of $1b be yr 0 figure?
2) Could you explain the answer for part (iii) on sensitivity analysis?
1) The question says that the $1billion is paid over 3 years (300 at the end of 2012; 600 at the end of 2013; and 100 at the end of 2014). It wants the NPV as at 1 Jan 2012, so the first payment is 12 months away (time 1) and so on.
The operating surplus does not commence until the construction is complete and so the first surplus is at time 4.2) Sensitivity is measuring the % change in the uncertain flow(s) that would give an NPV of zero. So for each of them, you take the NPV and divide by the present value of the flow(s) in question.
(My free lectures on investment appraisal might be useful for you).Thank you for your reply Sir! I have difficulty determine the cash flow periods, is there any rule of thumb?
It is impossible really to give you a rule – the time periods depend on the wording in the question.
Do not think of them as ‘years’, because they are not – they are points in time.
So time 0 is ‘now, time 1 is 12 months from now, and so on.
Usually, we assume that operating cash flows occur at the ends of accounting years, so the cash flow during the first year of trading will arise in 1 years time (time 1), from the second year of trading arises in 2 years time (time 2) etc..
However, again, it does depend so much on what is stated in the question. In Seal, the question does state specifically that the investment will be made in three payments, and that the inflow starts to arise once the construction is completed.
You might find the free lecture useful (and the investment appraisal lecture for F9).
Thank you Sir, I’ll have a look.
How about the question on Sleepon – Dec 05. The question says it would be constructed and working in one year’s time, so time 0 is used to construct the theme park, shouldn’t the cashflows start in year 1 then?
victoriaaa:
You are correct in saying that that the park will start operation in one years time.
However, we always assume that operating cash flows occur at the ends of years (unless specifically told different).
So….suppose we have a year end of 31 December each year, and we start building on 1 Jan 2000 (time 0). Construction is finished as at 31 December 2000, and the first income arises during year ended 31 December 2001. For discounting purposes we treat it as being at the end of the year – i.e. 31 December 2001.
From 1 Jan 2000 to 31 December 2001 is a two year wait (we are not worried about the odd day 🙂 ) and therefore the first inflow is at time 2 and needs discounting for 2 years.
I hope that makes sense 🙂
(Elia-Shar-eK: Please do not answer in the Ask the Tutor Forums – you are not the tutor. Simple telling victoria that she had better sort it out is not actually helping much anyway!)
Thank you Sir, can I say that because time 0 is end of yr 0(31/12/00), finishes construction end of yr 1(31/12/01), and cashflows arise after 31/12/01?
OK – yes, no problem (subject to two things – first that you are referring to the cash inflows arising after 31/12/01 (because the cash outflows start now), and also that you are clear therefore that the first cash inflows will be in two years time.)
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