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Hi Sir,
In the March June 2023 acca question paper on the practice platform. Question 2 part b Oxwick acquisition of Ludham, when we are calculating the Discounted free cashflows from year 5 onwards. Wouldn’t we use (the free cash flow of 337.3) i.e. (337.3 *1.05/0.12-0.05) *1.12^-4 as opposed to the marking scheme which states we use 355.9m the value before the incremental investment?
Is there an error in the marking scheme?
This would change the answer to the gains acquired by Oxwick as they would obtain 13.9% gain as opposed to the 20.1% gain in the marking scheme which result in the acquisition not being acceptable.The answer is correct.
When using the growth formula for a growing dividends starting at time 1, then Do is the current (i.e. time 0) dividend, and the result is the present value at time 0.
Here, the growing flows start at time 5 instead of at time 1, which is 4 years later. So for Do we use the flow at time 4 (because it is 4 years later than time 0) and the result is the present value at time 4 (because again it is 4 years later than time 0). We then need to discount the answer for 4 years to get the present value at time 0.
Really sorry to jump in on this but I just solved this question and had a similar doubt, the free cash flow that they have used as Do 355.9 which is before incorporating investment income but the free cash flow after deducting investment is 337.3.
The question states that :
“After four years, the annual growth rate of free cash flows is expected to be 5% for the foreseeable future. It is assumed that there will be no additional capital investment from year 5 onwards.”
So I think the doubt is whether the 5% increase is on the cash flow after accounting for investment or before.Sorry both – I was not exactly answering the question.
However there is no investment income.
There is a cash outflow of the extra investment needed in each of the first four year, but it is assumed that there is no addition investment from year 5 onwards and so the answer is correct to use 355.9.
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