I am having a little trouble determining NPV. If a company acquires land 5yrs ago at a cost of $200,000. The current fair value is $500000. The co uses a discount rate of 10%. What is the relevant cost of the land for the factory NPV calculation? A) $200,000 B) $310,000 C) $322,102 D) $500,000
C. 200,000 * (1+10/100)**5 = 322,102.
Thanks. Shouldn’t I be using the $500,000?
It’s the accounting rule LCM that you can’t use 500,000.
Good question. Why shouldn’t it be $200,000? Isn’t that the carrying cost of land on balancesheet?
Could somebody clarify why we are discounting the 200,000. I thought we should be using historical cost, since it was purchased 5 years ago?
you are not discounting here… you are calculating the FV of 200000 from 5 years ago at the current discount rate – appreciating the land upwards…
I think he was asking why don’t use just use the original cost of 200k, which I think should be the cost used, rather than the compounded value… 10% is the discount rate the comp uses for its project, not that’s associated with the fair market appreciation rate of the land, and I don’t think it’s common or even allowed to mark up the value of your assets like that (from what I remember, you can mark down, i.e. impairment, but marking up before sale is like recognizing paper gains, I don’t think that’s allowed, could be wrong though) livelylatin, was this an actual question? and what is the answer?
i too originally thought 200K is all that should have been recognised. but goel_ar posted the answer – no other “objections” so I kinda ate my own words and did not voice any concern with all of that… My mistake though! CP
We need to calculate the FV of 200K that was spent 5 years ago, to get the real worth (time value of 200K at present date) N =5 I/Y = 10 PV = 200K CPT- > FV = 322102 Answer is C - Dinesh S
It is not a balance sheet issue, so it is not about historical costs, etc. It is a little confusing as I never think of “future” value as net present value, as in this problem. When you calculate an NPV problem you are figuring out the present value of some future value(s), not the other way around. So this question is not worded correctly, in my opinion.
I think this question is stupid. would have picked A
hmm… I am thinking again… How about if we were asked --(might not be valid question) A company acquires land at a cost of $200,000. The fair value after 5 years will be $500000. The co uses a discount rate of 10%. What is the FV of NPV five years from now? NPV(0) = 500,000 /(1.1)**5 - 200,000 = 110,460.66 ==> NPV(5)=110,460.66 *(1.1)**5=177,898. or As per original question – NPV(5) =500,000 - 200,000*(1.1)**5=177,898
Answer should be 500,000. I went back and checked the CFAI book about this and they had an example that covered this issue. (CFAI book 4, page 11)
Does US GAAP allow to mark up land assets? I am forgetting it(dont have my books here), IAS has a provision for this though. If it allows then the answer should be 500,000 else 200,000 the discount rate there seems to be extra info.
it’s like, what is this compounded value? is it historical cost? no. is it fair market value? no. the answer should be between the historical cost, which is 200k and the fair market value, which is 500k, like I said, that 10% they gave is for the comp, not for the property in the question, how can you use that as the compound rate for the property to assess its “fair market value”, plus, what’s there to assess, they already told you what the fair market value is in the question… after reading the question again, the way its currently worded, the answer is probably 500k, since you’re trying to determine the npv of a factory which is built on this land, so it’d make sense to use the fair market value, which is what you have to pay today if you don’t already own the land
For NPV…you should use the opportunity costs
I thought I read somewhere under US GAAP you can never write up an asset. Is this correct? If so, we shouldnt be appreciating the land (calculating future value) I would have picked 500K
liaaba it was an actual question. I was also getting a bit confused by using the correct figures.
But whats the answer?