# Discounted Cash Flow Techniques

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1. says

Hi
With regards this tutorial, why is it that no tax benefit is associated with the asset in the year it is disposed? I would have expected a tax benefit of 570 *0.25*0.25 (balance at end of year 4 x charge for year 5 x tax effect of charge for year 5). Please assist!

• says

this i mean before we make a determination of whether there should be a balancing allowance or charge and the tax effect thereof.

• says

No – the only tax effect when a non-current asset is sold is the tax on the balancing charge or allowance (as is in the lecture).

(Ignore this bit if it confuses, but the point is that you are allowed to get a total tax saving of 25% (the tax rate) of the total drop in value of the asset – in this case it drops in value by 800 (1800 cost less 1000 sale proceeds) and so the total tax saving will be 25% x 800 = 200. However, year by year you get the saving on a reducing balance basis, and then in the final year there is the balancing charge or allowance which makes the overall total tax saving equal to the 200. If you add up all the tax benefits over the years, then it does come to a total of 200 (subject to roundings))

• says

Thanks. I get this. What I don’t understand is why there was no capital allowance in the year of disposal. Is the disposal presumed to occur at the start of the year? If so should we not do away with revenues and costs in the year of disposal? The calculation of the balancing charge clearly assumes there is no capital allowance in the year of disposal and I want to understand why this assumption is made. I hope clarifies my question.

• says

The rule for the capital allowance calculation is that it is 25% reducing year for every year except the final year. In the final year there is either a balancing allowance or a balancing charge depending on the amount of the sale proceeds. It has nothing to do with when the asset is sold during the year.
(A balancing allowance is a capital allowance, a balancing charge is simply a negative allowance)

(That is the rule, although in fact even if it was allowed to have 25% in the final year it would end up with the same result – all that would happen is that the balancing charge or allowance would change, but the net result would be exactly the same )

• says

Thanks John, I see what you mean.

2. Hi Sir,

Consider this. \$US/Sterling
Spot 1.9456-1.9210
3 Months Forward 1.9066-1.9120
1 year Forward 1.8901-1.8945

Borrowing Investing
Sterling up to 6 months 5.5% 4.2%
Dollar up to 6 months 4.0% 2.0%

We need to pay \$1,150,000 in 5 months time, What will be the interest rate for borrow an equivalent pound now for.

• says

I don’t know what you mean by ‘equivalent’ pound.

However the interest rate for borrowing pounds is 5.5% per year, and so the interest for 5 months borrowing will be 5/12 x 5.5%.

• I actually mean the interest rate for borrowing pounds, The interest rate of 5.5% is for up to 6 months, Which according to the answer was 0.08333 which I don’t know how they got it.

• says

Either you have misread the answer or there is a typing error.

The interest rate for depositing dollars for 5 months is 5/12 x 2% which equals 0.833% (or 0.00833).
The interest rate for borrowing pounds is 5/12 x 5.5% which is 2.29% (or 0.0229)

• Thanks Sir, I think it must be a typing error, The question is actually from Kaplan revision Kit. Qn No 20 (LAMMER Plc)

3. Hi sir
Thanks for the lectures, I have one question to ask, Its from December 2008 Exams Question one (BLIPTON), I real don’t know how Project operating cash flow (Nominal) is calculated at the return Phase.

Thanks

• says

I guess you are clear as to how the real cash flows have been calculated – these are the cash flows ignoring inflation. (If you are not clear about any of them then do post again).

The nominal cash flows are the actual cash flows – i.e. taking account of the inflation (which in the UK is 2.5% per annum.

So…….the first cash flow is \$52,000 in real terms, but this is received 2 years after the start of the project and so we need to add on 2 years inflation. 52,000 x (1.025^2) = 54,633
Similarly, the second cash flow is 490,000 in real terms, but is received at time 3 and so we need three years inflation at 2.5% per annum. 490,000 x (1.025^3) = 527676

And so on

• Thanks you very much sir, I will always remain thankful to you

• says

Yes – it is covered in chapter 12 of the course notes. On the index of lectures it is chapter 11 – the impact of financing.

• says

thankx alot sir

4. says

@toobaalvi in as close to a lay man explanation as i can, i understand or treat so i understand working capital to mean its like pettycash. ie you already have taxable income from your sales, and you are told you need to have a buffer cash set aside for incidentals and is readily availed towards the project hence you would have already paid the tax for the same money when you received it as revenue etc. or from the source you raised it with.

The Tutor will answer both of us with a better answer, it just helps me to think of it that way!

• says

To be honest it does not matter how you think about it provided that you accept that there will be no tax implications, and that (unless you are told otherwise) you will get it all back at the end of the project.

(Although it is not really petty cash – it is money to finance extra receivables and extra inventory. These would not affect the tax liability, and at the end of the project you no longer need to finance extra receivables etc and so you get the money back )

• says

dear sir whatis difference between ACCA and FIA

• says

Foundations in Accountancy are a series of exams set by the ACCA that give certificates in basic accounting.

The ACCA Qualification is a full professional accounting qualification for which you have to take 14 examinations.

You can find full details of both on the ACCA website http://www.accaglobal.com

5. says

@Cara you meant for Accounting rate of return, thats when you need taxable profit and all. However the Tutor will correct me if iam wrong, it seems P4 (atleast from what i have covered to date assumes that to be carry forward knowledge hence it does not cover that revision, but that does not mean its irrelevant to do it .

2. I also wanted to make an observation on the 20% Fixed Overheads, that statement can be confusing in the exam, i know by now we understand irrelevant vis a vis relevant costs in decision making, and that it then means whether this project is embarked on or not the company will still pay the \$1000,000. But once the question says ‘should be absorbed ‘ it tends to imply they arise because of the project and could have been avoided etc. (thats the confusion to watch out for)

The other one is for tax (Payed immediately or one year later ! the later one implies we add for the above example another year 6! as for the (Current prices of inflation! this information are a must to watch out for in the exam!) especially during the reading hours highlight them and scribble what effect they should have e.g whether you start the inflation in year 1 or after year 1.

Otherwise it would indeed be a welcome gift to get such a straight forward question in an exam setting!

6. says

@Cara i remember thats what my lecture also said for F9 i think then we used to get instances where we had to do an accounting rate of return or something, The syllabus i have covered for P4 i havent seen it touched as a method to use in evaluating investments, In any case when explained we have been mostly made aware of its shortcomings as a basis for appraisal method for a projects. as compared to NPV and IRR.

Admin, I missed the part on why we are not using the 20% Fixed Overheads, i do remember from my previous study though that certain costs are irrelevant in decision making because whether you take on the project or not you still incur them. So is the same logic applied here?!

2. I will practice more examples i have noticed if ever we get an easy question like this one we would be lucky in the exam as the examiner seems to enjoy confusing us by throwing in all concepts in one question esp the compulsory section. Sometimes i really feel, what is important is really not the numbers but understanding the concept enough to apply it in real life situations. As this type of questions can just take too much of the exam time! in future the answer sheets should have the templates in advance! Whew.

7. says

may i know the timing we should start to claim capital allowance?
from my understanding, if we incurred capital expenditure in year 0, we should claim capital allowance in year 1 unless the question state otherwise. But, should i apply the same concept if first year allowance is given in the question?

• says

time 0 is not a year – it is a point in time.

If you watch the lecture it makes it clear (and if necessary watch the relevant F9 lectures).

However, in P4 do not worry too much about the timing – it depends on assumptions (as does so much of P4). If you state your assumptions then you will get the marks (provided obviously that they are sensible assumptions )

8. says

helo sir,

can we tear out the formula sheet, the present value table and the annuity table during the exam time, so that its earsier for us to see the rate and save up time,no need to flip the question booklet many times.

thanks

• says

I suggest you send this question to the ACCA… and please post on opentuition the reply from them thanks!

9. says

Hello Sir,

thank you for this lecture , again very well explained I have one question in relation to NPV. I just looked in my notes from F9, and my lecturer then ask us in calculation of NPV first include capital allowances in calculation of taxable profit than calculate and deduct tax and than add capital allowances back. So the tax effect is at the end the same as in NPV which you presented. I remember that my lecturer justified this approach because taxable profit which include capital allowances was needed in the calculation of something else, and well I don’t remember now where did we use it. Could you please tell me where we we can use such a profit, and if it will be used in the calculation in P4

• says

For F9 it does not matter which way you deal with the capital allowances. The answer will be the same whichever way.
For P4, the same usually applies. The only thing at P4 is that in one question it was the case that if there was a taxable loss, then it was made clear that you could not offset it against other profits (and therefore not simply get a tax saving) but that the losses were carried forward.
However, to be honest it is best you leave worries about that until P4 – for F9 it does not matter which way you do it. Whichever way you find the easiest to remember

• says

@springy, see what I have written below in reply to somebody else.

Fixed overheads are only relevant if the total changes as a result of doing the new project.

• says

@springy,
incemental fixed cost(project related)
step fixed cost
are relent costs….

10. says

In the NPV (e.g 1) question we inflated the sales and costs at different inflation rates, which essentially mean that we considered the nominal cash flows. In that case, aren’t we supposed to consider the nominal rate as well which is the real rate inflated at the general inflation?

• says

@Ruzz Su, Yes – certainly.

However, the nominal cost of capital is the actual cost of capital. Since all the question says is that the cost of capital is 10% we must assume that it is the actual (i.e. nominal) cost of capital. We would always assume this unless we were specifically told the ‘real’ cost of capital.

(Additionally, since the question does not give the general rate of inflation, the again we have to assume that the cost of capital given is the actual WACC i.e. the nominal rate.)

11. says

Fixed overheads are only relevant if the total fixed overheads for the company increase.

If the questions simply says that some of the overheads are allocated to the project, it does not mean that the total expenditure changes.

(The point is that for profit purposes a company change split the overheads between projects any way that they want to, but again, the total cash flow for the company only changes if the total fixed overhead bill changes.)

12. says

hi please can you just confirm why we didnt take into account of fixed overhead cost?
thanks