Monthly vs annually dcf in feasibility study
Hi guys, I recently had an opportunity to conduct a feasibility study for an upcoming condominium project.
I base outside of US, so some terms and practices may be different(and my English may not be perfect) I will try to be as clear as possible.
The project's expenses occur on a monthly basis (overhead, construction cost, fee, other expenses). Project' s revenues also occur in a monthly basis (down installment, contract fee). My company normally pays interest to a bank (for this kind of project) on a monthly too.
Therefore, I constructed my cashflow in a monthly scheme. I did monthly dcf in order to comply with an actual cf period as much as possible.
Here is where I faced a glitch. I submitted my analysis result and study to the committee, so they can give a go-no-go for the project. One of the committee raised a question to me " Why did you discounted your cf monthly, why not annually?"
I simply replied " expenses, revenues, interest, and other cf occur monthly, so it's appropriate to use monthly dcf."
He then said "I haven't seen anyone use monthly dcf for their projects before. I'm no finance major (he was an architect and a construction expert), but even AN....(very famous company) do it annually."
I replied "Annually dcf would be appropriate if interest and other cf occur in a big one time payment per year. I simply did it monthly because it complimented with an actual situation of our project. Discounting our project monthly and annually will result in a very different outcome."
He then asked me to go back and conduct both monthly and annually dcf then compare them side by side.
Did I do it wrongly? Should I make everything into a lumpsum then use annually dcf instead?
If I was right to use monthly dcf for my case, do you have any texts book or credible source recommendation that I can use as a reference, so I can show him or put it in a report to justify my analysis. My textbooks since the time I was a college student were long gone.
Sorry for the long post, but would really appreciate your advice and reference recommendation.
I work for a developer building condos and all of our CF models are monthly...
Agree with the monthly approach. For a development in particular, returns will be overstated if you use annual.
Whether monthly or annually is preferred is moot since it sounds like you're hired in a consultant capacity, so you should do whatever the requester has asked. With that said, I agree with you that monthly is more common and makes more sense. Just provide both analyses and let him compare.
Hi guys, thank for the sharing. Well, I eventually added annual analysis to the report and show side-by-side analysis results comparing monthly and anually dcf. Despite the fact that Irr and NPV from both way were drastically different, I was fortunate enough that both dcf deemed the project feasibility the same way (it's financially feasible). That way, I wouldn't have had to go through a nightmare of a splitted result.
That brought me to a question. What if Irr and/or NPV of both monthly and anually dcf were not conform. I would suggest them to go with a monthly version.
However, what should I use in order to justify my selection when the guy didn't buy it the first time I explained to him. (about when should annually dcf be used and why it's appropriate for our project to use monthly dcf.)
I kinda feel responsible for them to choose the proper method that will reflect their investment best too. Can't bare it knowing they might risk their money choosing wrong dcf (no matter monthly, quarterly, anually, etc.) in the future not because of calculated decision, but because they felt like it.
A monthly is more “accurate” (as accurate as a proforma can be) because it is more granular. If you are presenting an IRR you should use the monthly.
Let's just reiterate the basics (which you probably already know). A "go" on the IRR is when the IRR is equal to or higher than your required rate of return.
Required rate of return: 10% IRR: 12%
Answer: Go
If you have the granular data to create a monthly CF then you use the monthly IRR and the monthly IRR decision. You justify the use of the monthly discounting by indicating that you have access to the granular data and that a monthly CF is therefore most accurate.
There really is no "go" decision on the NPV. Your NPV will be $0 at the IRR. The only time you use the NPV to make your "go" decision is when there are two mutually exclusive projects. The project with the higher NPV is the go.
So, the very first thing to do is set aside the NPV unless your client is asking you to compare projects. If not then don't worry about it.
Looks like the question is already answered, but I will continue with the poll. Monthly is the proper way to go if you have access to the information. Annual is used--and it's used often--when you don't have access to granular numbers, which you did have. The guy you were talking to doesn't know what he's talking about.
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