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Apart from the examiners solution, is there an alternative method…, of discounting the expected cash flows in perpetuity .
They used a very easy method.
They calculated all total future cash flows beginning from year 5 onwards.
They assumed that every year after year 4, the cash flows will be the same as in year 4.
As we are adding the same amount perpetually, we calculate the total by dividing the amount by cost of capital expressed as decimal number.
(1-0.3) just takes into account 30% of tax.
When we have the sum, it is from year 5 onwards.
Then we have to calculate its present value at year 0 by using discount factor for 4 years for 12% cost of capital (discount factor of 0.636)
Although personally I believe that it would be better to discount it by factor for 5 years which is 0.567 but obviously I am wrong and hopefully will get enlightened by December.As for alternative, if you deduct 4 years of cash flows discounted by 12% from perpetual cash flows not discounted, you will get similar result, but not exactly the same.
Hope it helps.
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