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In the question it is stated that, ‘it can be assumed that the assembly plant can be built very quickly and the production started almost immediately’. Does this mean that the timing of the cashflows are same for the initial investments and the operating cashflows for the first year of operation?
I am a bit confused that in the answer the examiner assumes that initial investment is in year 0 and Operating CFs for first year is in year 1. It is stated in the assumptions section that the expectation to start the operations almost immediately is an unrealistic expectation. At the same time the expectation of the government of Yilandwe to bring down the inflation rates significantly in a short span of years is not unrealistic!
Will it be wrong to assume that the company’s expectation to start the production immediately is reasonable and to consider the timing of the stated CFs as same year?
When discounting, time 0, 1, 2 etc are points in time that are one year apart.
Time 0 is the start of the first year.
Time 1 is the end of the first year / start of the second year.
Time 2 is the end of the second year / start of the third year
and so on.We always assume that operating flows (i.e. revenue and running costs) are at the ends of years unless specifically told otherwise.
This is fundamental for all DCF investment appraisal questions and if you are at all unsure then do watch the Paper FM lectures on investment appraisal.
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