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Dear Mr Moffat
Question Omnikit from BPP book asks us to evaluate if a UK firm should undertake the diversified project in Switzerland or the US using NPV. The information supporting for the evaluation of the 2 projects are in current price thus the answer inflate the cashflows to reflect the money term.
Please would you advise if we could use the real rate in this case to calculate the NPV ?
Thanks
Hanh
No, you couldn’t.
You can only use the real rate on the current price flows if everything is inflating at the same general rate of inflation.
The problem here is that not everything is inflating at the same rate (the ending market values are not) but more of a problem is that the differential between the inflation rates is causing the exchange rate (and therefore the cash flows) to change. In addition, the tax is one year in arrears (but not one extra years inflation) and so that would need restating.I suppose there might be a way arithmetically of sorting all that out and discounting the current price flows, but it would be terribly messy and I certainly wouldn’t want to risk it in an exam!
Dear Mr Moffat,
With regards to the cash in/out at the end of the project, say the cost for demolish or costs to clear site, if the question is silent (it just state that the demolish cost in X years’s time is U$ 1 mil ) does it mean the cost is at current price?
Many thanks ,
Hanh
If it is silent then you would assume it was an actual cash flow.
However, always state your assumptions – there is rarely one correct answer to a P4 question. It depends on your assumptions and provided that your assumptions are reasonable then you will get the marks.
Dear Mr Moffat,
You make it clear and I am being relieved with your explanations.
Thank you very much.
Hanh
Dear john wid ref to the same Q im having confusion between wt is the yr of asset’s life n in which year savings would fall e.g the value 4800 …describe which yr is it of machinery’s life n in which yr saving wud fall? Also explain y therz no balancing allowance as the asset does hve residual value. Lookin for some detailed explanation on this…. 🙂
The question says that the machine is sold in 6 years time and so the proceeds occur at time 6.
It also says that they are after-tax proceeds, and so any capital allowance effect has already been taken into account.
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