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Hi John,
I’m a little confused, in the example in the lecture notes on page 54.
In relation to purchasing the asset, it says that the machine will be needed for 4 years, and (if purchased) will have a scrap value after 4 years of $10,000.
In year 4, I would have taken the cost ($42,200 less the scrap value of $10,000) and then multiplied this by the 30% tax rate to give year 4 capital allowance but in your lecture you have completed this in year 5.
I always thought that if the investment was for 4 years (in this case) then year 4 is the last year and you would deduct the scrap then and not in year 5 as you have done in the video.
When would it be case that if the investment was for 4 years that you would deduct the scrap at year 4 and not carry on until year 5 or would this not be a situation in the exam?
Also, is there no tax saving (as well as capital allowances) if you purchased the asset or is it just the capital allowances when purchasing?
Thanks very much
GrahamThe capital allowance calculated in the 4th year is the tax written down value of $42,188 (not the cost) less the scrap value of $10,000). This reduces the taxable profit of the 4th year but since tax is payable one year after the end of the financial year, the tax saving does not occur until time 5.
I do suggest that you watch the earlier lectures on investment appraisal with tax, because this is all explained in the lecture (and tax being payable one year in arrears is relevant in most NPV questions – not just lease v buy questions).
Thanks very much John.
After rewatching the lecture it makes sense. That part in brackets where is says Corp Tax is payable one year after the end of the financial year threw me off but your rule about the payment being at the start of the year puts tax saving in year 2 and when the payment being at the end of year puts tax saving in year 1 is a handy rule to have.
Just to clarify, the above scenario is generally for Lease vs Buy as anytime I’ve seen an NPV with Corp Tax being paid one year in arrears was always put into Year 2?
Thanks again
GrahamThe same situation could occur in any question, but it is most likely in a lease v buy question.
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