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Dear John,
I am confused for part b of BRT Co:
They have already known us nominal rate of 12%. The sales figure I take is year 4 for onward i.e, $2308 (nearest to $1000). I deducted the 4years annuity and applied 1/r formuale correctfully as far as I saw you doing this. But my answer is incorrect.I took 2308, I took D.F as 1/0.12= 8.33, then I deducted 4years annuity 3.037 = 5.293.
Then: 2308 * 5.293= $12216. Now NPV= -$2000 + 12216 = $10216Can you correct me?
Many Thanks
What you have done would be correct if there was no inflation after year 4 (i.e. if the later cash flows were to be constant).
However, since there is 3% inflation you have no choice but to use the dividend growth formula (Po = D1/(re-g)).
Even though these are not dividends, you can use the same formula to get the present value of any inflating perpetuity.But I saw the answer:
They took 2308 * (1 – 0.30)/0.12 = 13463
then they inflated: 13463 * 1.03 = 13867
then they done it at present value of 4th year = 0.626 * 13867 = 8681
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I have deducted and used annuity value for it as 5.293, I dont know if its wrong. But it doesn’t suit to the examiner answer 🙁
I do apologise – I have had so many questions on here today that I ended up looking at the wrong question 🙁
Everything you have done is fine, except that you forgot the 30% tax.
So, after tax it is 2308 x 70% = 1615.6
The perpetuity is 1/0.12 = 8.333.
The 4 year annuity is 3.037. Subtracting gives 5.296.Multiply 1615.6 by 5.296 gives 8556. (The answer gives 8562, but the difference is purely due to round the discount factors to 3 decimal places (honestly!) and you would not lose marks for this.)
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