My question is if the net operating flow was a loss, i.e. a negative value (401) in the first year how would we deal with the tax on operating flows and in tax savings on capital allowances for the next year?

We always assume (in Paper F9) that the company is already making profits from other projects and is therefore already paying tax.

Therefore if the operating flows from this project are negative then it will save tax (because the total profit of the business will be lower).

So we deal with the tax on operating profits in exactly the same way as always – if there is a positive operating flow then there is a tax outflow; if there is a negative operating flow then there is a tax inflow.

Capital allowances are not affected – the tax savings on them will be the same whatever happens.

If the are extra (incremental) overheads payable by the company as a result of doing the project, then it is a relevant cash outflow (of the extra amount) when getting the net cash flows each year.

Why is the material cost 864 in the first year and not 800? Wouldnt you buy the material on day one so therefore there would be no inflation in a day hence why Im confused why we do not use 800.

The lecture is saying if we do buy the machine it would be next year that we would buy the material, but if we decide to go ahead with the project and buy the machine tomorrow then wouldnt we then buy the material tomorrow aswell so therefore no inflation?

We assume that the price increases on the first day of each new year. It may be impractical, but that is the assumption we make.
Also, the term “current prices” automatically always means in the exam that in one year it will inflate by one year, two years inflation in two years time, etc..

You would ignore it because it is not a cash flow.
(Depreciation is always ignored. Capital allowances are only considered because of the affect on the tax.)

Have you watched the previous lectures, because I spend time on the timing of the cash flows in them.

It is not ‘year 0’ it is time 0, which is a point in time. Time 0 is ‘now – the start of the first year. Time 1 is one year from now – the end of the first year / start of the second year, and so on.

We always assume that operating cash flows occur at the ends of year (unless told differently in the question), so although we will be buying materials throughout the first year, we assume that the cash flow occurs at then end of the first year i.e. at time 1.

yes, i have watched the previous lecture. i got your point now, i have figure out the where i have made a mess, the mess was on different between time0 and year o. you made it very clear now. thank you so much for your kind reply. its so nice of u . thumbs up…:)

in the NPV calculation, for discount factor calculation what do we use if we have given only real cost of capital 5.7%

inflation is 5%

do we use the formula (1+nominal rate)=(1+real rate)x(1+inflation rate), i used this formula but still does not give a round % to use for discount factor.

The lectures are all working fine, so the problem is definitely at your end.
Best is to go to the support page (the link to it is above). If the suggestions there do not sort out the problem then leave another message on that page and admin will try and help you.

With regard to a general inflation rate it is impossible to know for certain but countries do make ‘predictions’ and so we would have to use that.

With regard however to the inflation applicable to specific flows, then it is really down to estimates.

It is impossible to predict inflation precisely (just as it is impossible to be able to predict cash flows precisely, even without inflation). All decisions have to be based on estimates and therefore it is impossible to make ‘perfect’ decisions.

i apologize for asking this silly question umm for capital allowance why is it not written in year 1 column ? it starts from the first year till it is sold so why it’s not written in year 1-3 ?

sorry i should have read the question carefully it is mentioned in question that the new product will be sold 20p.u in the first year…sorry my mistake…

We always assume that the business is already making profits from other sources, and is therefore already paying tax.

As a result, a ‘loss’ in any year from this investment isn’t really a loss, it simply reduces the profits they are already making and therefore saves tax they would otherwise have been paying.

Hey John,
Here is a confusion with Bpp question for inflation:

I figured-out everything almost correct somewhere, but the working capital is really disturbing me. I share you portion of the question and also answer for that portion:

Inc/Dec. in working capitals are as follows:
Year 0: 20×3= +20000
Year 1: 20×4= +10000
Year 2: 20×5= -15000
Year 3: 20×5= -15000

The inflation is to be increased by 10%( applied to 20×4 and onwards). The project is 3years.

What I did:
20×3 year forward to 20×4= 30000 * 1.10 = 33000 ( this is correct)
BUT
20×5 = -15000 * 1.10 = -16500 +33000 = 16500 ( Incorrect )
same for 20×6

I will answer, but please post questions like this in the Ask the Tutor Forum for Paper F9 – not here, which is for comments on the lecture.

Without inflation, the requirement at time 2 is 15,000.
But there will be two years inflation at 10%, so the actual requirement will be 15,000 x 1.1 x 1.1 = 18150.
(you have only inflated it for one year, but there will be two years inflation)

Fixed overheads are only relevant if the total changes. Simply absorbing (or charging) the total fixed overheads differently does not mean that the total changes.
I do stress this in my lecture.

Sali says

Great lecture Sir.

My question is if the net operating flow was a loss, i.e. a negative value (401) in the first year how would we deal with the tax on operating flows and in tax savings on capital allowances for the next year?

Thanks in advance.

SALI

John Moffat says

We always assume (in Paper F9) that the company is already making profits from other projects and is therefore already paying tax.

Therefore if the operating flows from this project are negative then it will save tax (because the total profit of the business will be lower).

So we deal with the tax on operating profits in exactly the same way as always – if there is a positive operating flow then there is a tax outflow; if there is a negative operating flow then there is a tax inflow.

Capital allowances are not affected – the tax savings on them will be the same whatever happens.

Sali says

I got it. Thanks Sir.?

John Moffat says

You are welcome

mehreen245 says

sir what do we need to do if we got extra overheads relevant to this project

John Moffat says

If the are extra (incremental) overheads payable by the company as a result of doing the project, then it is a relevant cash outflow (of the extra amount) when getting the net cash flows each year.

Paul says

hello,

Why is the material cost 864 in the first year and not 800? Wouldnt you buy the material on day one so therefore there would be no inflation in a day hence why Im confused why we do not use 800.

The lecture is saying if we do buy the machine it would be next year that we would buy the material, but if we decide to go ahead with the project and buy the machine tomorrow then wouldnt we then buy the material tomorrow aswell so therefore no inflation?

John Moffat says

We assume that the price increases on the first day of each new year. It may be impractical, but that is the assumption we make.

Also, the term “current prices” automatically always means in the exam that in one year it will inflate by one year, two years inflation in two years time, etc..

fahim231 says

what would you do with depreciation if there was no capital allowances?

John Moffat says

You would ignore it because it is not a cash flow.

(Depreciation is always ignored. Capital allowances are only considered because of the affect on the tax.)

fahim231 says

so say for example the question said depreciation is absorbed into the fixed costs, would you have to take away depreciation from the fixed costs?

John Moffat says

Yes – you would. We are only concerned with cash flows and depreciation is not a cash flow.

arman90fy says

Hello sir

one things i am confuse about is , if we dont buy the material now on year 0, then how we gonna produce the product to sale on year 1?

John Moffat says

Have you watched the previous lectures, because I spend time on the timing of the cash flows in them.

It is not ‘year 0’ it is time 0, which is a point in time. Time 0 is ‘now – the start of the first year. Time 1 is one year from now – the end of the first year / start of the second year, and so on.

We always assume that operating cash flows occur at the ends of year (unless told differently in the question), so although we will be buying materials throughout the first year, we assume that the cash flow occurs at then end of the first year i.e. at time 1.

arman90fy says

yes, i have watched the previous lecture. i got your point now, i have figure out the where i have made a mess, the mess was on different between time0 and year o. you made it very clear now. thank you so much for your kind reply. its so nice of u . thumbs up…:)

zubeyde says

in the NPV calculation, for discount factor calculation what do we use if we have given only real cost of capital 5.7%

inflation is 5%

do we use the formula (1+nominal rate)=(1+real rate)x(1+inflation rate), i used this formula but still does not give a round % to use for discount factor.

Thank you

John Moffat says

In that case you would discount using the nearest % – the examiner expects you to use tables rather than calculate the discount factors exactly.

However it is very unusual to be asked to use real rates. Usually we inflate the flows and then discount at the actual cost of capital

zubeyde says

Thank you so much

Asheem says

Thank you John for this beautiful Lecture.

Samoar says

Serious problem:

I have been trying for 2 days, 5 hours in total, but cannot watch any of the lectures. The rest of the site is doing fine.

On my Google Chrome browser, I have increased the font size as otherwise I get a headache. Could that be the problem?

What can I do?

PLEASE HELP !!

John Moffat says

The lectures are all working fine, so the problem is definitely at your end.

Best is to go to the support page (the link to it is above). If the suggestions there do not sort out the problem then leave another message on that page and admin will try and help you.

Samoar says

Thanks

Rana Mateen says

Sir i want to ask from where we can get inflation rate which we can use for our investment appraisals in real practical life?

John Moffat says

Well…..there are really two answers to this.

With regard to a general inflation rate it is impossible to know for certain but countries do make ‘predictions’ and so we would have to use that.

With regard however to the inflation applicable to specific flows, then it is really down to estimates.

It is impossible to predict inflation precisely (just as it is impossible to be able to predict cash flows precisely, even without inflation). All decisions have to be based on estimates and therefore it is impossible to make ‘perfect’ decisions.

Rana Mateen says

thanks Sir I got it now.

fahad says

i apologize for asking this silly question umm for capital allowance why is it not written in year 1 column ? it starts from the first year till it is sold so why it’s not written in year 1-3 ?

John Moffat says

The first capital allowances are indeed calculated at the end of the first year (i.e. time 1).

However, the second to last line of the question says that the tax is 1 year in arrears.

As a result, the benefit of the capital allowances will not occur until 1 year later – i.e. time 2.

mani1 says

why you did not incorporate inflation in year 1 for sales?… its a little bit confusing point for me otherwise great lecture …..

mani1 says

sorry i should have read the question carefully it is mentioned in question that the new product will be sold 20p.u in the first year…sorry my mistake…

Emil says

Mr Moffat, I’m confused about tax. Please, could you clarify for me how tax savings can be more than tax paid? What does it mean in real life?

John Moffat says

We always assume that the business is already making profits from other sources, and is therefore already paying tax.

As a result, a ‘loss’ in any year from this investment isn’t really a loss, it simply reduces the profits they are already making and therefore saves tax they would otherwise have been paying.

acca2050 says

Hey John,

Here is a confusion with Bpp question for inflation:

I figured-out everything almost correct somewhere, but the working capital is really disturbing me. I share you portion of the question and also answer for that portion:

Inc/Dec. in working capitals are as follows:

Year 0: 20×3= +20000

Year 1: 20×4= +10000

Year 2: 20×5= -15000

Year 3: 20×5= -15000

The inflation is to be increased by 10%( applied to 20×4 and onwards). The project is 3years.

What I did:

20×3 year forward to 20×4= 30000 * 1.10 = 33000 ( this is correct)

BUT

20×5 = -15000 * 1.10 = -16500 +33000 = 16500 ( Incorrect )

same for 20×6

What Book did:

20×3 20×4 20×5 20×6

$ $ $ $

Investment @20X3 prices 20,000 30,000 15,000 0

Investment @inflated prices 20,000 33,000 18,150 0

Year Move @inflated prices (20,000) (13,000) 14,850 18150

I am curious how 18150 and onward figures arrive

Many Thanks

acca2050 says

Oops I think this part is confusing to read: WHAT BOOK DID:

I’m doing it again here for easy reading:

I’m convinced for till year 20X4, lets start onward periods;

20X5:

Investment @20X3 prices: $15000

Investment @inflated prices: $18150

Year Move @inflated prices: $14850

20X6:

Investment @20X3 prices: $0

Investment @inflated prices: $0

Year Move @inflated prices: $18150

John Moffat says

I will answer, but please post questions like this in the Ask the Tutor Forum for Paper F9 – not here, which is for comments on the lecture.

Without inflation, the requirement at time 2 is 15,000.

But there will be two years inflation at 10%, so the actual requirement will be 15,000 x 1.1 x 1.1 = 18150.

(you have only inflated it for one year, but there will be two years inflation)

acca2050 says

ok cool! Thanks

hamzaharoon says

Hi Sir,

I Can’t Understand Why you have not Treated with FIXED OVERHEADS in this Calculation?

John Moffat says

Fixed overheads are only relevant if the total changes. Simply absorbing (or charging) the total fixed overheads differently does not mean that the total changes.

I do stress this in my lecture.

Tyler says

Hi Sir, I got a bit confused and did not understand the last bit of this lecture regarding the loss relief?

John Moffat says

I was just saying that for F9, loss relief is not relevant.

If they make profits they pay tax, if they make losses they save tax.

Tyler says

So, for yr 1, the adjusted profit is 401 and C.A of 700, hence the tax savings of 75, how about for year 2? Is it a loss or profit?

John Moffat says

Is what a loss or a profit? Why do you care anyway?

In year 1 there is a cash profit of 401 and so tax payable of 100 at time 2.

There is tax saving from capital allowances at time 2 of 175.

In year 2 there is a cash profit of 435 and so the tax on this is 109 payable at time 2.

There is also a tax saving from capital allowances of 131.

sdmaalex says

Fantastic Lecture!

M Fauzi says

Such a clear lecture from a great lecturer!! Many, many thanks.