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The question requires some mistakes made in the calculation of project CFs to be amended.
Year 0 and Year 1 are investment phases with an investment of $150m in Y1 and $50m in Y2.The error is that interest of 8% per annum on a proposed $50m loan has been included in the project’s past tax CF before tax has been calculated.
Now, I understand that we have to add back the interest of 8% on the loan (net of tax), but from which year? Year 1? Or Y2 when sales begin?
In answer, it has been done from Y1, but I don’t understand why.
I don’t know which answer you are looking at (maybe you are finding it in a Revision Kit), but I have the examiners original answer in front of me and the interest has been added back from the second year onwards.
The question does not make it clear when the loan was taken, but given that it is for $50M (and therefore they presumably have the money available for the remainder of the investment) it makes sense not to borrow the money until needed at the end of the first year, and therefore the first interest will be in the second year.
Thank you so much for the response. It does make sense now, but would it be considered okay if we add back interest from Y1 (considering the question doesn’t really specify), or would marks be deducted? Or should we write down this assumption at the end of our answer?
Thank you 🙂
I doubt you would lose marks (this question was set by the previous examiner and he did often word questions badly). However to be safe always in AFM write down your assumptions (and most Q1’s specifically ask you to state your assumptions because so often different assumptions are valid) 🙂
Thank you so much for such timely responses. Really really appreciated 🙂 Have a great day!
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