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Hi John, my doubt in this question is:
Given: Tax allowable depreciation is assumed to be equivalent to the amount of investment needed to maintain existing operations. However, an investment in assets (including working capital) will be required of $630m in year 1. In years 2 to 4, investment in assets each year will be $0·50 of every $1 increase in sales revenue.
However I noted no TAD was considered in the calculation of taxation.
I keep thinking about it but I can’t not figure out. Please advise me.They are two separate things.
The profit margin is 6%, so the profit at time 1 is 2,596. Given that this is the profit, it will be after depreciation and therefore the tax will be 28% x 2,596.
Depreciation is not a cash flow and so in Paper FM we would then add back the depreciation. However, as I state in my free lectures, the line in the question about it being equivalent to the amount needed to maintain existing operations means that there will be a cash outflow of the same amount and therefore there is no need to add it back.The investment in assets of $630 etc.. is an extra investment and therefore is a cash outflow.
Thanks for your explanation, and it really help me a lot. The wordings of the question sometimes confused me.
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