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Hi John,
1)Regarding sensitivity can we calculate it as the NPV/PV of construction cost or operating surplus or decommission expense, is there a reason why its done differently?
For example: Sensitivity to Construction cost 122.2/843.4=14.49%
Sensitivity to operating surplus 122.2/1059.7=11.53%
Sensitivity to decommissioning costs 122.2/94.1=129.8%The sensitivity of decommissioning costs is the only answer with a minor difference
2) Using the formula to get the annuity why use 30 why not 34 because Y02 is time 1, Y03 is time 2, Y04 is time 3 so Y05 should be time 4 and in total with the 30 years it should be 34 unless the expected life starts from time 1 then it makes sense to use 30?
3) the formula gives us the annuity for 30 years so couldn’t we take that figure and less the annuity for 3 years so 14.11-2.487 then multiply by 100, however this gives a different present value for cash inflows from the answer?
1. What you have done is fine. I don’t know why the examiner did it differently (it was the previous examiner and he did several things in an odd way 🙂 )
2 and 3
The flows start at time 4 and last for 30 years, so they are 4 – 33 (not 34, if you actually count up 🙂 )
You can discount in either of two ways
Either (and this is what the answer has done) take the 30 year annuity discount factor and then multiply by the 3 year ordinary discount factor (because the annuity starts 3 years later – at time 4 instead of at time 1).
Alternatively, you could take the 33 year annuity factor minus the 3 year annuity factor.Both approaches would result in the same answer (apart from small rounding difference which is irrelevant).
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Thank you very much John 🙂
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