April 2010 Exam - Que 9(ii)

In the April 2010 exam, Que 9(ii), the DPP is calculated as 8.1 which makes sense to me - then 2 is added to it to get 10.1. I know the income stream doesn't start for 2 years but that is taken account of in the formula - can someone explain - thanks.

 

It is taken out of the formula because DDP-2=t
The stream starts at the beginning of year 3 so to obtain PV you have to discount it for 2 years V^2 and multiply by PV value of the stream at the begining of year 3 during t .

DDP=t+2 because we want the time from the point 0(in time).

 

Yes but the formula used to get DDP is 5+3v^3/12=v^2*1.7*a-bar-n - so the v^2 already deals with the 2-year discount doesn't it?

 

5+3v^3/12=v^2*1.7*a-bar-n THIS formula does not calculate DDP
it gets n where n+2 = DDP

V^2 discounts the value of 1.7 a bar for n years.

DDP is counted from the start so 2 years( V^2) plus n .

I invite you to check the definition of DDP(which DOES NOT state that ddp is counted from the start of income stream )

 

Thanks for that. So is t the number of periods until the project is profitable from the time of the first positive cash flow?

 

yes

 

Thanks for the explanation. It explained a lot!!


Just asking a hypothecial question....

what if there are two cashflows in the question (one starting at time period n1 and one starting at time n2)

Would we then use n + min(n1,n2) = t?

Regards,
Sunil

 

I'm not sure I understand what your n and t represent.

To calculate a DPP (no matter how many cashflows you have), you need to calculate the length of time (measured from the start of the project) until the project moves into profit.

 

Hi - sorry to but back in but now I am confused. In the April 2009 Exam Que 5, the question looks similar to me in that the income doesn't start until the 8th year so after getting the the result of T=10.93, I would have expected us to add 8 to get DPP=18.93 but in this case DPP=10.93 - can someone explain that for me please?

 

there is no reason to expect DDP to be at 18.93 because there is NO cashflow income at that point in time.

Watch how Pv income till time T is constructed.
T is DDP .

 

You're right - 18.93 should have stuck out as an error since the income is from 8 to 12 but lets assume the income stream was from 8 to 20. Both exam questions have outgoings starting from t=0 and income starting some years later. I am still missing why one is discounted back 2 years and the other is not discounted back.

 

It's to do with the way in which the variable t is defined. Since you'll be writing your own answers in the exam, you can choose the way in which you define t.

You could choose:

- t to be the length of time from the outset of the project (as has been done in this second question you refer to). Since the DPP is the time until profit measured from the outset of the project, then in this case t gives you the DPP (or you round up to the next cashflow after t if income is discrete).

- t to be the length of time from the start of the receipt of income (as in the original question you refer to). Since the DPP is the time until profit measured from the outset of the project, then in this case you'd have to add on the time period from outset until the income starts to find the DPP (and round up to the next cashflow if income is discrete).

In all cases, the DPP is the time until profit measured from the outset of the project. What variables you define in a question to work this out is up to you. The important thing is that you know what you've defined, so you can calculate the DPP properly.

 

Ok - the penny just dropped. In the first case, my formula was 5+3v^3/12=v^2*1.7*a-bar-t which accounts for the 2 year lag with v^2 so I was thinking t included that lag but looking now with my eyes actually open I see that t is from the 2 year mark. Thanks all for persevering with me in what in the end is actually quite a simple point.

 

Could you tell me how would you then solve the first question assuming the first method?

 

You mean April 2010, Q9 (ii)?

I think you'd just replace t (or n, or whatever variable you're using to represent the time from when the income starts) with t-2.