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Hi Sir
In Smartwear (March/June 2019) – there is an NPV analysis and we’re asked to comment on the NPV analysis itself. The task is:
4 (b) Evaluates the marketing department’s NPV analysis that supports the CDMS investment, questioning any underlying assumptions made.
Info provided in the exam:
The NPV analysis, in the case study, includes a deduction for tax payments (it doesn’t include additions for potential tax allowances), but the discount factor provided, doesn’t specify whether the ‘after-tax’ discount factor has been applied. I have a few related questions:
1. It is correct, in every NPV, that there should always be a deduction for tax – if tax is being suffered?
2. There should be a separate cash inflow representing any tax allowances/or this should be netted against the respective tax charge (including any adjustments being made for deferred payments and allowances)?
3. Whenever the cash flows include a tax charge (which I presume is often going to be the case), then, specifically, an ‘after tax discount factor’ should be applied to those net cash flows, to discount them back to PV?
4. If there are taxes being charged, but the analyst forgets to include those tax impacts on the cash flows and so the net cash flows omit the impact of taxes, but the analyst does remember to apply an ‘after-tax’ discount factor – would it be more sensible to suggest that the figures are recalculated to include the net tax impacts, without actually going through the process of recalculating the NPV ourselves?
Thank you,
Ali
1 Yes. Tax is a relevant cash flow.
2 It should not matter whether you show rwo tax cash flows or net them off – provided the correct timing is ised.
3 Yes. If there is tax the post tax discount rate must be used as this lowers the effective interest cost and tnis will lower the WACC. The post tax,discount rate is then applied to post tax cash flows.
4 it depends on tje question. If you are simply asked to comment on assumptions, and errors methods there is no need to recalculate NPV. If you are aaked to provide a better or more accurate analysis then a new NPV calculation is implied.
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