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Why sre we not adding back tax allowable depreciation of
Year 1 2 3 4
8 2 1.5 0.5
We have dedcuted them for calculation of tax and not added them back. Please help.
Thank yoy 🙂The tax workings have been shown separately and the TAD has been subtracted in the calculation of the tax.
However the TAD have not been subtracted in arriving at the net cash flows in the first workings in the answer and therefore there is nothing to add back.
By all means subtract the TAD from the incremental profit in the first bit of workings, then calculate the tax on the taxable profit, and then add them back. I assume that is what you did when you attempted the question and you will have arrived at exactly the same answer.
I am sorry for the trouble. I understand your answer but they have deduction it from incremental profit here in calculation of tax and not added it back.. could you please tell me how to calculate it alternatively.
(a) All figures are in $ million
Year 0 1 2 3 4
Sales revenue (inflated, 8% p.a.) 24.87 42.69 61.81 36.92
Costs (inflated, 4% p.a.) (14.37) (23.75) (33.12) (19.05)
–––––– –––––– –––––– ––––––
Incremental profit 10.50 18.94 28.69 17.87
Tax (W1) (0.50) (3.39) (5.44) (3.47)
Working capital (W2) (4.97) (3.57) (3.82) 4.98 7.38
Investment/sale of machinery (38.00) 4.00
–––––– –––––– –––––– –––––– ––––––
Cash flows (42.97) 6.43 11.73 28.23 25.78
Discount factors (12%, W3) 1 0.893 0.797 0.712 0.636
–––––– –––––– –––––– –––––– ––––––
Present values (42.97) 5.74 9.35 20.10 16.40
–––––– –––––– –––––– –––––– ––––––
Base case net present value is approximately $8.62 million.(W1) All figures are in $ million
Year 0 1 2 3 4
Incremental profit 10.50 18.94 28.69 17.87
Tax allowable depreciation 8.00 2.00 1.50 0.50
–––– –––– –––– ––––
Taxable profit 2.50 16.94 27.19 17.37
–––– –––– –––– ––––
Tax (20%) 0.50 3.39 5.44 3.47
–––– –––– –––– ––––I know what they have done and I do not think you have read my reply properly.
There would only be any reason to add it back had it been subtracted in the first bit of workings arriving at the net cash flow each year. Had it been subtracted there and the tax calculated there, then we would add it back because it is not a cash flow.
Here, it has not been subtracted in arriving at the cash flows in the first workings and therefore there is nothing to add back. The tax workings have been shown separately.
I repeat, do it the way you are suggesting and you will end up with exactly the same answer 🙂
If you are still unsure then look back at my Paper FM lectures on investment appraisal with tax. In Paper FM we deal with the tax the way that you want to, but in Paper AFM although you can do it that way in this question, it is safer to calculate tax as separate workings because the investment is often abroad and gives rise to tax losses, as I explain in my Paper AFM lectures.
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