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Hi Sir,
1) In the question SLEEPON HOTELS, we incur a tax loss in the year 2 & 3. The Exam Kit solved it by adding the ‘Loss * Tax Rate’ amount back to the loss.
Why did this happen?2) Why is the Revenue starting from Year 2? (I saw your previously provided response to the same question, but wasn’t able to understand).
Thank You!
1. The new investment is in the same country, so just as any profit from the investment increases the total profit of the business and therefore results in extra tax payable, similarly any ‘loss’ from the investment reduces the total profit of the business and therefore results in a tax saving. This is the normal way of treating investments in the same country and I do explain this in my free lectures.
2. The fourth paragraph of the question states that it will be constructed and working in one years time. Therefore there will be no revenue in the first year and the first revenue will be in the second year.
I still am unable to understand the logic behind the 1st point. A similar condition appeared in ZHICHI (Sep/Dec 21), there’s a loss and the tax is being subtracted from the loss, which is decreasing it. Why is this happening.
Sorry for so many questions.This is always the treatment where the investment is in the same country (just as in Paper FM)..
We are looking at the effect of the new investment on the cash flows of the company as a whole.
The company will currently be making profits and will be paying tax. If the new investment makes a ‘loss’ then it will reduce the existing profit of the company and therefore the company will be saving tax as a result. As always a cash saving is effectively a cash inflow.
Have you watched our free lectures?
Yes I have seen most of the lectures on YouTube.
Regarding the statement “cash saving is effectively a cash inflow”, cash saving does not cause any flow in cash. Then why is it being added in this case, where we are trying to calculate the Net Cash Flows.
As I wrote before, we are looking at the cash flow effects on the company as a whole.
If the company is saving tax then it is exactly the same effect as if the company is receiving cash.
It is the same with all cash savings, whether because of tax or because of anything else.
It may help you to watch the Paper FM lectures on investment appraisal, because it is the same principle in all DCF appraisal.
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