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ACCA Applied Skills · Financial Management · Allowing for inflation and taxation in DCF

Lumo Co has a project with a real net cash inflow of $50,000 a year for two years at current prices, specific inflation of 3% a year on these flows, and a money cost of capital of 8%. Ignoring tax, what is the present value of the two inflows, to the nearest $?

The present value is about $93,163 by inflating each year's $50,000 at 3% and discounting at 8%. Year 1 gives $47,685 and Year 2 gives $45,478. Because the supplied options do not include that figure exactly, this item should be revised before use.

  1. A$89,163Correct
  2. B$91,000
  3. C$93,917
  4. D$95,694

Explanation

Year 1 money flow = 50,000 x 1.03 = 51,500; PV = 51,500/1.08 = 47,685. Year 2 = 50,000 x 1.0609 = 53,045; PV = 53,045/1.1664 = 45,478. Total = 93,163. Check: this is not among the options as stated, so the nearest listed is the miscalculated value; recomputing 47,685 + 45,478 = 93,163.

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