Tax effect

Yes, you are right that I’m confusing the fact that since the machine was bought on last day of accounting period (in lease & buy) so the first tax-saving would be at Time 1 because the cash flow was on the last day of the accounting period. So I thought that since the License Fee is payable on the last day of accounting period same rule is going to apply but why not the first tax-saving on license fee was on Time 1?

In your lecture investment appraisal with tax what you stated I have completely understood that if tax is one year in arrears then the tax flow occurs one year after the end of the accounting period which is at time 2 [since this is not a normal NPV question rather it is a lease vs buy so this is not going to apply here – so no problem here :)]

But the question, ASOP Co is a lease vs buy question where you stated the rule at the end of the lecture which is going to apply if the tax is paid one year later (i.e. in arrears).

Since you mentioned a different rule for lease & buy questions when tax is in arrears which are:
1) If first cashflow is on first day of accounting period then the first tax effect will be on Time 2
2) If first cashflow is on last day of accounting period then the first tax effect will be on Time 1

So if any cashflow is on the first day of the accounting period then its tax-saving cashflow will be on Time 2; Otherwise, if any cashflow is on the last day of the accounting period then its tax-saving cashflow will be on Time 1 (which is the case in ASOP Co).

I still don’t understand your explanation and I don’t know what you are referring to when you say that you didn’t say!)

Since the license fee of $104,000 is payable at the end of the first year (i.e. last day on 31 Dec) which means that the first cashflows of the license fee is on the last day of the accounting period therefore the first tax effect would be at Time 1 (rather than Time 2 as mentioned in the answer)

There is a rule that you wrote at the end of the lease n buy which I already mentioned to you in my earlier response many times!

If we take the tax-saving on license fee & put it at time 2 because the tax paid is in arrears (which you said earlier which would be a case in normal NPV question) then what is the point of having a rule which looks at the first cashflows and then we have to see the timing of tax & tax-savings?

I’m confused with the fact that in Chap 9 example 3 where we buy the machine, the outflow is on the last day of accounting period so the tax is calculated immediately at Time 0. In this case, the tax flow is one year after the end of the accounting period, which is Time 1;

Therefore in ASOP Co the License fee was also payable at the end of the year (i.e. last day – just like the machine was bought on last day) the outflow is on the last day of accounting period so the tax is calculated immediately at Time 0. In this case, the tax flow is one year after the end of the accounting period, which is Time 1.

What you said about Tax effect in the lecture on Investment Appraisal with Tax is different than what you said in the Lease & Buy lecture where you give us a rule specifically used for lease n buy questions only..