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Dear John,
There has been one question regarding perpetuity in BPP book:
An organisation with a cost of capital of 14% p.a is considering investing in a project $500,000. The project would yield nothing in Year 1, but from year 2 would yield cash inflows $100,000 p.a in perpetuity.
Assess whether this project is worthwhile to undertake:Suggested Answer:
Year 0: (500,000)
Year 1: 0*0.877
Year 2: 100,000*(1/0.14*0.877)=626,429
NPV=126,429 –worthwhile undertakingHowever my workings are:
Year 0: (500,000)
Year 1: 0*0.877
Year 2: 100,000*(1/0.14-0.877)=626,600
NPV=126,600 – worthwhile undertakingOn this occasion, although I chose to take the project, my workings are indeed incorrect.
I know that I should not use 1/0.14-0.877 as in year 1 there is no cash inflows so perpetuity should not be applied. But my question is that why we should apply 0.877 for one year for all cash inflows from year 2 to forever? I think we should apply 0.877 on year 3 only. Is anything wrong in my statement?Also, if the
0.877 (14% first year)
0.769 (14% second year)
And the question has been rewritten as there is no cash inflows in year 1 and year 2, from year 3 to forever there are constant cash inflows for 100,000 p.a, should we calculate the NPV as:Year 0 (500,000)
Year 1 0.877*0
Year 2 0.769*0
Year 3 to levelling off 1/0.14*0.769*0.877*100,000=481,724So NPV=(18,276)–not worthwhile undertaking.
Is that correct above?Thanks a lot!
Have a nice day!
Your workings are fine – you can do it either way.
The reason the PV’s are slightly different (626,429 as against 626,600) is simply due to the rounding of discount factors – the tables only quote the 1 year discount factor to 3 decimal places.
This is irrelevant in the exam (and is the reason most questions ask for the answer to the nearest thousand).If the perpetuity starts at time 3, then either you multiply by 1/r and then multiply by the 2 year discount factor because it starts 2 years late.
Or alternatively you multiply by 1/r less the annuity factor for 2 years.Again, apart from rounding, the answers will be the same.
Many thanks John!
Do you think this is a silly question as BPP has left less content for that and your note mentioned this part less as well ==?
As I heard from some fellow students that F9 are transferring to be the 50:50 for calculation and narration (the focus of calculation has been weaken). Should I expect to practise less for question with less calculations?
Thanks a lot!
Have nice day!
I don’t know exactly what you mean about leaving less content 🙁
Paper F9 has always been about 50% calculation and 50% written – this has been the case since F9 first appeared and there is no change.
If you have watched my Introductory lecture for Paper F9, I make this very point 🙂
@johnmoffat said:
I don’t know exactly what you mean about leaving less content 🙁Paper F9 has always been about 50% calculation and 50% written – this has been the case since F9 first appeared and there is no change.
If you have watched my Introductory lecture for Paper F9, I make this very point 🙂
Hello John,
The ‘less content’ means the little focus regarding such calculations (the there is a gap year without any cash inflows).
For previous sessions, I think ACCA has a strong focus upon calculation component in F9 paper but recently, ACCA are about to actually strike a balance for narrative and calculation elements. One fellow student told me that I just need to be comfortable with business valuation and NPV/IRR/WACC and CAPM for tackling the calculations in Section B in order to score well in Sec B. What do you think?
Have a nice day!
The ACCA have not changed the policy about calculations and written. I was at a meeting with the examiner in February and it was made clear that the mix between calculation and written will remain the same for F9 as always – approximately 50% of each.
Your fellow student is wrong. Although those areas are important areas, they alone are not enough to score well in section B. You need to be confident of all areas – working capital management, foreign exchange risk management etc. are just as likely in section B.
@johnmoffat said:
The ACCA have not changed the policy about calculations and written. I was at a meeting with the examiner in February and it was made clear that the mix between calculation and written will remain the same for F9 as always – approximately 50% of each.Your fellow student is wrong. Although those areas are important areas, they alone are not enough to score well in section B. You need to be confident of all areas – working capital management, foreign exchange risk management etc. are just as likely in section B.
Thanks John!
I have a further question: before using your F9 and F8 lectures, I have already read the BPP study text for F8 and F9 (I finished about 50% for each of them). I now have the latest revision kits. What should I do further? Should I stop using the study text and watch your lectures; and then I practise questions in the revision kits?
Thank you once again for your help!
It is up to you, but I would use the study text more as a reference book and use it for areas that you are not sure about from the lectures, or areas where you want to read more.
@johnmoffat said:
It is up to you, but I would use the study text more as a reference book and use it for areas that you are not sure about from the lectures, or areas where you want to read more.Thanks John!
Have a nice day!
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