You have studied investment appraisal previously so most of this chapter will be revision for you. Of the few new items in this chapter, the most important is Modified Internal Rate of Return and you should make sure that you learn the technique involved.

### Net present value calculations

Here is a list of the main points to remember when performing a net present value calculation. After we will look at a full example containing all the points.

- Remember it is cash flows that you are considering, and only cash flows. Non-cash items (such as depreciation) are irrelevant.

It is only future cash flows that you are interested in. Any amounts already spent (such as market research already done) are sunk costs and are irrelevant. - There is very likely to be inflation in the question, in which case the cash flows should be adjusted in your schedule in order to calculate the actual expected cash flows. The actual cash flows should be discounted at the actual cost of capital (the money, or nominal rate). (Note: alternatively, it is possible to discount the cash flows ignoring inflation at the cost of capital ignoring inflation (the real rate). We will remind you of this later in this chapter, but it is much less likely to be relevant in the examination.)
- There is also very likely to be taxation in the question. Tax is a cash flow and needs bringing into your schedule. It is usually easier to deal with tax in two stages – to calculate the tax payable on the operating cash flows (ignoring capital allowances) and then to calculate separately the tax saving on the capital allowances.
- You are often told that cash is needed to finance additional working capital necessary for the project. These are cash flows in your schedule, but they have no tax effects and, unless told otherwise, you assume that the total cash paid out is received back at the end of the project.

nenaoz says

Hi Ken,

Is this still relevant for March 2020 sitting?

lylim5309 says

Hi, may i know how to get positive $200 at year 5 under working capital ? and what is the implication of the fixed overhead ?

Spiro says

Regarding 200K$ positive WC CF, last bullet in 2. Net present value calculations:

You are often told that cash is needed to finance additional working capital necessary

for the project. These are cash flows in your schedule, but they have no tax effects and,

unless told otherwise, you assume that the total cash paid out is received back at the

end of the project.

teju06 says

Hi, please can you confirm how the tax on saving on capital allowance is calculated in the final year (107)?

Thank you

Ken Garrett says

At the start of yr 5 the tax WDV will be 1800 x 0.75^4 = 570

Balancing chrge is 1000 -570 = 430

Tax on this = 0.25 x 430 = 107

jbouwer says

Good day

Please can you advise on how you reached the “tax on saving on capital allowance” in example 1?

When I calculate it I get the following (y1 and y2 only for illustrative purposes):

y1: 200,000 x 25% (allowance) = 50,000 x 25% (tax rate) = 12,500

y2: 150,000 x 25% (allowance) = 37,500 x 25% (tax rate) = 9,375

Please assist.

Thanks!

jbouwer says

Figured it out… I was using the additional working capital amount and not the capital amount at the start of the project (1,800,000), it would then be:

y1: 1,800,000 x 25% = 450,000 x 25% = 112,500 allowance

y2: 1,350,000 x 25% = 337,500 x 25% = 84,375 allowance

Hope it helps anyone else.

Rameez says

Hello can anyone help me with this calculation of NPV on calculator?

irinaprouss says

Can you please check wether this lecture is available on-line? While all the other lectures are well played, this one is not.

opentuition_team says

yes it is on line. reload the page please