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Discounted cash flow techniques (part 1) – ACCA (AFM) lectures

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  2. HI John Moffat
    WHAT ADJUSTMENT DO WE DO IF WE ARE TOLD THAT ” it can be assumd that the amount of taxallowable depreciation is the same as the investment needed to maintain Company operations”

  3. Hi Sir, I didn’t understand the Tax on saving on capital allowed. How these figures are calculated 113, 84, 63, 47, and 107. I believe the method is not the same as in the video lecture. Can you please explain it to me.
    Secondly, in the notes’ answer, the tax is directly calculated on operating profit while in the video lecture you are calculating after deducting the Capital allowance.

    • Just as in Paper FM (was F9) you can do it either way (and get the same answer).

      Either subtract the capital allowances, then calculate the tax, then add back the capital allowances, or alternatively calculate the tax on the profit before allowances and then calculate the tax saved due to the allowances. (The allowance in the first year is 450 and therefore the tax saved is 450 x 35% = 113. Same for the later years.)

      If you are still unsure then watch the Paper FM lectures on investment appraisal with tax for revision.

  5. Hello John,
    kindly explain me as i did not understand the fact why Capital allowances were deducted first and then again added back i-e what is the logic behind it,
    Are’nt capital allowances are relevent cashflows if they are not then why do we subtract and add them ?

    • Capital allowances (tax allowable depreciation) are not cash flows (just as accounting depreciation is not a cash flow).
      We subtract it in order to get the taxable profit on which the tax is calculated.
      Having calculated the tax we then add it back because it is not a cash flow.

      I suggest that you watch the Paper FM lectures on investment appraisal with tax, because this is revision from Paper FM (was Paper F9).

    • Because in the final year there is a balancing charge or balancing allowance. If you have forgotten the way we deal with tax then do look back at the ‘investment appraisal with tax’ lectures for Paper FM (was F9).

  7. Hello Sir,

    Thanks for the amazing lectures?
    I have a doubt regarding NPV calculation. If we are financing a project through equity issue and incur issue cost on the equity market issued.

    Do we include the equity issue cost as a cash outflow in NPV calculation ?

  8. Hi,

    Please can you explain why you do not use the method shown in FM by calculating and deducting tax on the operating cash flows then dealing with the capital allowances after.

    Thanks

    • In Paper FM the investment is always in the same country as the company, and we always assume the company is already making profits and paying tax. Therefore they always get the benefit of the tax saving on CA’s even if the operating profit from the investment is less than the CA’s.

      In AFM the investment is often in another country in which case the tax is in the other country and if the investment makes a tax loss (because the CA’s are greater than the operating profit) then there is no tax payable for that year and the loss is carried forward to reduce the taxable profit in later years.

      If there are no tax losses then either approach will give the same answer, but because there are quite likely to be tax losses in an AFM question with an investment in another country, it is safer to take this approach.

  9. Dear sir,
    There should be no taxation in year making loss, if any carried forward amount which should be included in next year of profit. So I got confused with the taxation in year 1, should we deduct into taxation in year 2 instead?
    Thank you very much for the lecture.

    • Just as in Paper FM (was Paper F9) we always assume that the company is already making profits and is already paying tax. Therefore a ‘loss’ from a new project simply reduces the company overall profit and therefore reduces the overall tax payable – therefore there is a tax saving to be made (and no loss relief).
      (It may help you to watch the Paper FM lectures on investment appraisal with tax)

      The exception to this is where there is an investment in a foreign country. In that case if. the project does have a loss, then the loss is carried forward and reduces the taxable profit in the following year. I show this in a later example.

  10. Hi!

    I have a question on capital allowances.
    Could you please explain why do we calculate capital allowances taking 1,800 as a basis?
    Shouldn’t we calculate Depreciable Cost (as the Actual cost minus Scrap value) and work with it further?
    I mean, why don’t we calculate basis for depreciation as:
    1,800 – 1,000 = 800, and calculate dpn further with reducing balance approach:
    Dpn in Year 1: 800 * 25% = (200)
    Dpn in Year 2: (800-200)*25% = (150)
    Dpn in Year 3: (600-150)*25% = (112.5)
    Dpn in Year 4: (450-112.5)*25% = (84.38)
    Dpn in Year 5: Balancing figure = (253.12)
    Total Dpn for 5 years: (800)

    A little bit confused..

    Many thanks for video lectures!

    Nick

    • I don’t know whether or not you have taken the tax paper, but capital allowances are always calculated on the initial cost. Any scrap proceeds are dealt with at the end and result in a balancing charge or allowance.

      We are not calculating accounting depreciation, we are using tax rules (and the tax people do it the way I do in the lecture (and the way we do in exams)) because the tax people have no idea what scrap value there will be (if any) until it is actually scrapped.

  12. Excellent lecture John! Still unclear on the materials and labour being inflated in year one, but the rest of it was brilliant. I hope you are keeping well.

    Your website is my first point of call each time there is an exam – albeit I have had to put proceedings on hold for the past year – so, in the nicest way possible, I hope to soon no longer require your help (on the count of this being one of the two remaining) 馃檪

    • Thank you for your comment – do ask in the Ask the Tutor Forum if you do have any problems.

      If you are told that flows are in current prices, then automatically they inflate in the first year.

  13. rorymcmonagle: It is of no relevance whether or not the project is ‘using them’. A fundamental concept involved in DCF investment appraisal is that we are only interested in the future incremental cash flows to the company as a result of doing the project. The total fixed overheads for the company will remain the same whether or not the project is undertaken. They are therefore of no relevance when deciding whether or not the project is worthwhile.

  14. Hi

    I dont understand why overheads of 20% of 1,000,000 are not included. If we are deciding they are absorbed by the project, we are deeming that the project uses them? Or is it that they would happy anyway without the project?

    Thanks

  19. 1-Shouldn’t the inflationary effects on materials and labour come into effect after the first year, i.e. reflected only in columns 2-5 for materials and labour?

    2-Why would working capital be returned at the end of the project? Wouldn’t it be likely put to use and used up over the course of the five years?

    • No to both, and I explain the reason for both in the lecture!!

      1, Materials and labour are given in current prices – i.e. the price quoted before we have even decided whether or not to go ahead with the project. If we do go ahead, then the price in the first year of the project will be higher by the rate of inflation.

      2. What do you mean by ‘put to use’?? Working capital is things like the fact they need to buy inventory of materials at the start of the project in order to facilitate production. Once production stops, the no longer need to carry the inventory.

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