1. avatar 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)
    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

    • avatar 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;
      Investment @20X3 prices: $15000
      Investment @inflated prices: $18150
      Year Move @inflated prices: $14850

      Investment @20X3 prices: $0
      Investment @inflated prices: $0
      Year Move @inflated prices: $18150

    • Avatar of 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)

    • Avatar of 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.

      • avatar 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?

      • Avatar of 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.

  2. avatar says

    I’m a little bit confused about the material inflation cost. Assuming that material is purchased equally throughout the year, wouldn’t the materials purchased at the beginning of the year be cheaper than those purchased at the end of the year? If that were the case, why wouldn’t we calculate using an average inflation rate (eg. 5% for year one, 15% for year two etc). Sorry if I’m being stupid! Thanks for your help.

    • Avatar of John Moffat says

      What you are saying is sensible in real life. However for the exam we always assume that the price goes up in ‘yearly jumps’. (It is a point you could make if a written part asked for the limitations of what you have done in the arithmetic.)

      • avatar says

        Thanks for clarifying that for me.

        One more thing. Even for exam purposes, would I presume that material is purchased in advance for the whole year (instead of at the end of each year)? Therefore, do I presume that in year 0, I buy a machine? But then I wait 12 months until the start of year 1, when I buy the material? Or instead should I assume that year 0 is the very start of year 1, and materials are not purchased until the end of the year?

        Sorry if I’m making life difficult, I just can’t get it clear in my head at the moment!

      • Avatar of John Moffat says

        Time 0 is the start of the first year. Time 1 is the end of the first year / start of the second year. And so on…..
        We always assume that operating flows (e.g. revenue, materials, labour etc.) occur at the ends of years (unless told otherwise).

        So the first years purchases will result in a cash flow at time 1, the second years purchases result in a cash flow at time 2 and so on. :-)

  3. avatar says

    Based on my residual knowledge, I thought when the depreciation rate is 20% it means the asset life is 5years or 25% it means it is 4years. But to my greatest surprise when the depreciation rate was 25% (four years based on default knowledge) and the investment under appraisal has a useful life of 3years, the depreciation working stopped at 3years instead of 4years. Is it that the question is NOT possible to come like that in exam , in other words, just used like that or we are to consider JUST the investment under the appraisal’s useful life of 3years ONLY in this case i.e. the example given and ignore the default rule. Indeed, you are great! Thanks a lot.

    • Avatar of elsie2009 says

      @rolake You are confusing depreciation with capital allowances. Depreciation is the accounting charge to the profit and loss over the economical useful life of an asset. Capital allowances are a reduction in tax payable on qualifying assets which reduces the amount of corporation tax owing.

      In addition depreciation is a notional accounting cost and not a CASH flow it is therefore not a relevant cost and should be ignored.

      • Avatar of John Moffat says

        Be careful – although capital allowances are usually reducing balance, there have been some questions where you have been told that they are calculated straight line. (I am only talking about Paper F9 obviously).
        The question will always tell you the capital allowance ‘rules’.

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