Question thread for March 2018

[nikaido]

Hi Mr Mofat,

In one if the question in bpp kit .. the value of company acquired via free cash flow was as expected .. future cash flows into growth over discount factor – growth .. however .. the answer was further multiplied against 0.909, which i dont understand why and the relevance ..

Following is the extract of the answer

Value of Ndege Co =
Present value of $7.62m free cash flow growing at 20% in the first year and discounted at 10%:
$7.62m × 1.2 × 0.909 = $8.31m
Add: present value of cash flows from year 2 onwards:
($9.14m × 1.052)/(0.1 – 0.052) × 0.909 = $182.11m
Less bond taken over by Ndege = $40m
Value to shareholders of Ndege Co = 8.31 + 182.11 – 40 = $150.42m

And the relevant question extract :

Ndege Co’s cost of capital is estimated to be 10%. It is estimated that in the first year of operation Ndege
Co’s free cash flows to firm will grow by 20%, and then by 5.2% annually thereafter

why 0.909 in reaching 182.11 please ? thanks

[John Moffat]

It is because the dividend valuation formula (which is what has been used – it works for any inflating perpetuity) assumes that the first flow is in 1 years time. In this case, the first flow is in 2 years time – 1 year later – and so the result needs discounting for 1 year to get back to the present value.

(Please title the threads according to what question you are asking about, and not just ‘March 2018’ 🙂 )

[nikaido]

Thanks . i got it ..

i was thinking to ask all the questions under this thread . One stop place . or would u prefer an additional post for every question relating to the March attempt i am appearing for?

[John Moffat]

I am please you have got it 🙂

You must start a new thread for new questions.

The reason is that our answers benefit all students – by using the search box on these pages you will find that often questions have already been asked by others, and already answered. We certainly cannot offer free private tuition 🙂

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