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  1. hi John! you are the best! I love your paste with passion.
    however, i’ld like to know when best to include depreciation in cash flow like in this example again ( I mean should it only be when it affects tax?).
    in addition, can you give some other examples of items (other than depreciation)that are not relevant cash flow.

    thanks a million

    • I do actually explain in the lecture.

      The question says that 20% of overheads are absorbed (charged) to the new project, but this does not mean that the total overheads increase. We are only interested in any extra cash flows as a result of doing the project, so if the total overheads do not change then there is no extra cash flow.

  3. Dear John,

    I am a little confused that the inflation rate for labour is different than the one for material. Should the rate not be equal for the same period?

    Kind regards

    Jens

    • But why? Although there will be a general rate of inflation in a country, that is only an average – not everything will inflate at the same rate. Think about oil prices – sometimes they go up more than other goods – sometimes the go up less than other goods.

  4. Great lecture Sir.

    My question is if the net operating flow was a loss, i.e. a negative value (401) in the first year how would we deal with the tax on operating flows and in tax savings on capital allowances for the next year?

    Thanks in advance.
    SALI

    • We always assume (in Paper F9) that the company is already making profits from other projects and is therefore already paying tax.

      Therefore if the operating flows from this project are negative then it will save tax (because the total profit of the business will be lower).

      So we deal with the tax on operating profits in exactly the same way as always – if there is a positive operating flow then there is a tax outflow; if there is a negative operating flow then there is a tax inflow.

      Capital allowances are not affected – the tax savings on them will be the same whatever happens.

    • If the are extra (incremental) overheads payable by the company as a result of doing the project, then it is a relevant cash outflow (of the extra amount) when getting the net cash flows each year.

  6. hello,

    Why is the material cost 864 in the first year and not 800? Wouldnt you buy the material on day one so therefore there would be no inflation in a day hence why Im confused why we do not use 800.

    The lecture is saying if we do buy the machine it would be next year that we would buy the material, but if we decide to go ahead with the project and buy the machine tomorrow then wouldnt we then buy the material tomorrow aswell so therefore no inflation?

    • We assume that the price increases on the first day of each new year. It may be impractical, but that is the assumption we make.
      Also, the term “current prices” automatically always means in the exam that in one year it will inflate by one year, two years inflation in two years time, etc..

    • Have you watched the previous lectures, because I spend time on the timing of the cash flows in them.

      It is not ‘year 0’ it is time 0, which is a point in time. Time 0 is ‘now – the start of the first year. Time 1 is one year from now – the end of the first year / start of the second year, and so on.

      We always assume that operating cash flows occur at the ends of year (unless told differently in the question), so although we will be buying materials throughout the first year, we assume that the cash flow occurs at then end of the first year i.e. at time 1.

      • yes, i have watched the previous lecture. i got your point now, i have figure out the where i have made a mess, the mess was on different between time0 and year o. you made it very clear now. thank you so much for your kind reply. its so nice of u . thumbs up…:)

  9. in the NPV calculation, for discount factor calculation what do we use if we have given only real cost of capital 5.7%

    inflation is 5%

    do we use the formula (1+nominal rate)=(1+real rate)x(1+inflation rate), i used this formula but still does not give a round % to use for discount factor.

    Thank you

  11. Serious problem:

    I have been trying for 2 days, 5 hours in total, but cannot watch any of the lectures. The rest of the site is doing fine.

    On my Google Chrome browser, I have increased the font size as otherwise I get a headache. Could that be the problem?

    What can I do?

    PLEASE HELP !!

    • Well…..there are really two answers to this.

      With regard to a general inflation rate it is impossible to know for certain but countries do make ‘predictions’ and so we would have to use that.

      With regard however to the inflation applicable to specific flows, then it is really down to estimates.

      It is impossible to predict inflation precisely (just as it is impossible to be able to predict cash flows precisely, even without inflation). All decisions have to be based on estimates and therefore it is impossible to make ‘perfect’ decisions.

  13. i apologize for asking this silly question umm for capital allowance why is it not written in year 1 column ? it starts from the first year till it is sold so why it’s not written in year 1-3 ?

    • The first capital allowances are indeed calculated at the end of the first year (i.e. time 1).

      However, the second to last line of the question says that the tax is 1 year in arrears.

      As a result, the benefit of the capital allowances will not occur until 1 year later – i.e. time 2.

    • We always assume that the business is already making profits from other sources, and is therefore already paying tax.

      As a result, a ‘loss’ in any year from this investment isn’t really a loss, it simply reduces the profits they are already making and therefore saves tax they would otherwise have been paying.

  16. Hey John,
    Here is a confusion with Bpp question for inflation:

    I figured-out everything almost correct somewhere, but the working capital is really disturbing me. I share you portion of the question and also answer for that portion:

    Inc/Dec. in working capitals are as follows:
    Year 0: 20×3= +20000
    Year 1: 20×4= +10000
    Year 2: 20×5= -15000
    Year 3: 20×5= -15000

    The inflation is to be increased by 10%( applied to 20×4 and onwards). The project is 3years.

    What I did:
    20×3 year forward to 20×4= 30000 * 1.10 = 33000 ( this is correct)
    BUT
    20×5 = -15000 * 1.10 = -16500 +33000 = 16500 ( Incorrect )
    same for 20×6

    What Book did:
    20×3 20×4 20×5 20×6
    $ $ $ $
    Investment @20X3 prices 20,000 30,000 15,000 0
    Investment @inflated prices 20,000 33,000 18,150 0
    Year Move @inflated prices (20,000) (13,000) 14,850 18150

    I am curious how 18150 and onward figures arrive 馃檨

    Many Thanks

    • Oops I think this part is confusing to read: WHAT BOOK DID:

      I’m doing it again here for easy reading:

      I’m convinced for till year 20X4, lets start onward periods;
      20X5:
      Investment @20X3 prices: $15000
      Investment @inflated prices: $18150
      Year Move @inflated prices: $14850

      20X6:
      Investment @20X3 prices: $0
      Investment @inflated prices: $0
      Year Move @inflated prices: $18150

    • I will answer, but please post questions like this in the Ask the Tutor Forum for Paper F9 – not here, which is for comments on the lecture.

      Without inflation, the requirement at time 2 is 15,000.
      But there will be two years inflation at 10%, so the actual requirement will be 15,000 x 1.1 x 1.1 = 18150.
      (you have only inflated it for one year, but there will be two years inflation)

      • So, for yr 1, the adjusted profit is 401 and C.A of 700, hence the tax savings of 75, how about for year 2? Is it a loss or profit?

      • Is what a loss or a profit? Why do you care anyway?

        In year 1 there is a cash profit of 401 and so tax payable of 100 at time 2.
        There is tax saving from capital allowances at time 2 of 175.

        In year 2 there is a cash profit of 435 and so the tax on this is 109 payable at time 2.
        There is also a tax saving from capital allowances of 131.

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