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Dear John Moffat
i have the difficulty with the folllowing:
1) An investment will produce an anuual return of $1500 in perpetuity with the first receipt starting in 3 year’s time. What is the present value of this perpetuity discounted at 8%?
Answer: $1 500* (1/0.08) = 18750
$18 750 * 0.857 = 16 068, 75I don’t understand why we don’t substract annuity 2 years (1.783):
$ 1500 * (1/0.08 – 1.783) = 16 075, 502) LW Co has a half empty factory on which it pays $5 000. If it takes on a new project, it will have to move to a new bigger factory costing $17 000 pa and it could rent the old factory out for $3 000 pa until the end of the current lease. What is the relevant cost of the project?
Answer: 14 000
why this logic wrong:
17 000 – incremental
(2 000) – saving
and how they get the answer
puzzled….Question 1:
You can do it either way and the only reason that the answers are slightly different is that the figures in the tables are rounded to 3 decimal places.
If there is a question like this as an MCQ, then the rounding will not be a problem (it will ask for the answer to the nearest $100 to avoid the problem)Question 2:
They will be paying the 5000 whether or not they take on the new project, and so the 5000 is not relevant to the decision.
If we do take on the project we will pay out 17000 (which we otherwise would not), but we will also receive 3000 (which we otherwise would not).
So the effect of taking on the project is a net extra payment of 17000 – 3000 = 14000
thanks for your help very much!!
i didn’t get the sense of Q2 due to poor reading, now everything is clear
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