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Hello John
A lease agreement has a net present value of $26,496 at a rate of 8%. The lease involves a payment of $10,000 followed by four equal annual payments.In my calc, i included the 10,000 as part of the figure in which the NPV is multiplied by to get the payment. Can you please explain why that is incorrect. My equation would have been ….Inflows x d.f.= 26,496
Your wording is a bit wrong, but you mean the right thing 🙂
I assume that the question wants to know the amount of the annual payment.
In which case, the annual payment x the 4 year annuity d.f. at 8% = 16,496
The reason that it must equal 16,496 is that the PV of 26496 is the present value of all the payments. If there is an immediate payment of 10,000, then the PV of this is $10,000 and so the PV of the remaining 4 payments must be the remainder. i.e. 26496 – 10000.
yes, my apologies…i forgot to mention what the question asked for. Thanks John for making the answer clear. I have another question here….
Peter plans to buy a house in 5 years time using cash, estimated cost is $1.5 mil. How much does he need to set aside each year for 5 years starting immediately earning a rate of 10% interest?
what i dont understand in the given answer is the use of the annuity factor.
when i worked it , i found the present value of 931,500 and divided by 5 yrs, but the answer continues and uses annuity factor …..i dont understand why. please explain.The PV go the house (931500) must be equal to the PV of the amount that he sets aside each year.
If the amount set aside each year is X, and the first amount is immediately (so the present value of that one is X) then the present value of all the amounts set aside will be:
X + (X x the annuity discount factor for 4 year). This must be made equal to 931500. Then you can calculate X.thanks for your response john. its still a bit confusing tho. …..”X + (X x the annuity discount factor for 4 year). This must be made equal to 931500. Then you can calculate X.” ….<<i don’t understand that part. Why is the annuity discount factor used and not the present value figures for the respective year?
Yes – he is putting aside an equal amount each year for a total of 5 years.
You could make the equation a lot more complicated by using the ordinary discount factor to discount each X separately, but because it is an equal amount each year it is much quicker and easier to use the total of the discount factors for each of the year – i.e. the annuity discount factor.
Hi, I have a question about the June 2014 paper question 1 a. I don’t know how to get the inflated sales income and variable cost for years 2, 3 and 4. Do you inflate the prices given or do you inflate the figures you get in year 1? I can’t get the same answer as the answer given. Thank you in advance for any help given, Andrea
You cannot inflate the figures you have in year 1 because the number of units are different!
In year 2, the sales figure is 13,000 units x $475 x 1.05^2 (for 2 years inflation).
The same logic applies to the other sales and variable cost flows.
Hi, I have a question from the BBP book which is the practice and revision kit for exams up to June 2015. My question is on question 50 Leaminger CO (FMC, 12/02, amended) page 40. In part b, we have to revise our NPV calculations from part a to take account of the capital rationing. Can you please explain to me why the Finance Lease Option stays the same and is unaffected by the capital rationing? Many thanks, Andrea
It is because the first payment on the finance lease is on 31 December. There is only capital rationing up to 30 December, so there is no problem paying the first (and subsequent) finance lease payments.
(In future, please start a new thread when it is a new question 🙂 )
Thanks John. That makes sense. I just need to read the question more carefully in future. Sorry, I’ll make note to do that next time. Thanks for your help 🙂
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