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ACCA FM · Guided practice (Show me how)

Chapter 8: Relevant cash flows for DCF

Tax and capital allowances in an NPV

A company has a year end of 31 December each year. It is considering the purchase of a new machine on 1 January 2003 at a cost of $10,000.

The machine is expected to generate net operating cash flows of $5,000 during the first year, $7,000 during the second year and $8,000 during the third year. It is intended to sell the machine at the end of the third year for $6,000. Additional working capital of $1,000 will be required at the start of the project.

Corporation tax is 30%, payable one year in arrears. Capital allowances are available at 25% a year on a reducing balance basis. The cost of capital is 10%.

Calculate the NPV of the project and advise whether it should be accepted. Sign convention: cash inflows positive, cash outflows negative. Time 0 = 1 January 2003; time 1 = 31 December 2003, and so on.

  1. (a) Capital allowances and tax savings

    Calculate the company's annual capital allowances, tax savings and balancing adjustment for the machine bought on 1 January 2003.

  2. (b) Cash flows and NPV

    Prepare the company's annual project cash flows from 1 January 2003, calculate net present value and state whether the machine should be purchased.

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