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When does the perpetuity of $20,000 begin

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › When does the perpetuity of $20,000 begin

  • This topic has 3 replies, 2 voices, and was last updated 4 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • October 15, 2020 at 3:55 am #588923
    Luna777
    Participant
    • Topics: 7
    • Replies: 6
    • ☆

    Dear John, here’s a question that I don’t understand…

    Question – BPP Revision Kit 111
    A company receives a perpetuity of $20,000 per year in arrears, and pays 30% corporation tax 12 months after the end of the year to which the cash flows relate.
    At a cost of capital of 10%, what is the after-tax present value of the perpetuity?

    It says the perpetuity is received ‘per year in arrears’, so I calculate the perpetuity from the second year using 20,000*(1/0.1-DF1), believing that ‘in arrears’ means the perpetuity will be delayed to the next year. However, the answer calculates the perpetuity from the first year, using 20,000*1/0.1. I don’t understand why. Could you please explain this? Thank you!

    October 15, 2020 at 9:19 am #588948
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    For discounting, cash flows occur at points in time that are one year apart.

    Time 0 (“now”) is the start of the first year.

    Time 1 is 1 year from ‘now’ and is the end of the first year / beginning of the second year.

    Time 2 is 2 years from’ now’ and is the end of the second year / beginning of the third year

    and so on,

    Here, the $20,000 is received in arrears, i.e. at the end of each year. So the first receipt is in 1 years time.
    (Had the $20,000 been receive in advance i.e. at the start of each year, then the first receipt would be at time 0 )

    Make sure you are clear about the way the timing works, because getting the timings correct in the exam is where the problem often lies – the discounting itself is easy 🙂

    October 15, 2020 at 10:07 am #588959
    Luna777
    Participant
    • Topics: 7
    • Replies: 6
    • ☆

    Thank you so much! It looks very clear to me now!

    October 15, 2020 at 2:49 pm #589006
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    You are welcome 🙂

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    Posts
Viewing 4 posts - 1 through 4 (of 4 total)
  • The topic ‘When does the perpetuity of $20,000 begin’ is closed to new replies.

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