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Hello professor,
I’m a bit confused about the questions that involve FCF calculations. Sometimes I see taxes being deducted to arrive at FCF. Sometimes I see tax allowable depreciation added, then taxes deducted, followed by tax allowable depreciation deducted. I can’t seem to figure out why different questions treat tax and tax allowable depreciation differently. Could you please explain why?
Thanks!
The tax is calculated on the operating cash flows less the TAD. However the TAD is not a cash flows. So either calculate the tax separately and then put it with the cash flows, or alternatively in the cash flows subtract the TAD, then calculate the tax outflow, then add back the TAD because it is not a cash flow.
This is what we always did for Paper FM. However there is one extra thing in Paper AFM in that if the investment is in a foreign country (as it often is in AFM questions) then there might be losses in which case we do not make the tax saving (as we do when the investment is in the same country) and the tax needs to be calculated separately and any losses are carried forward when calculating the tax payable.
If you watch my free lectures on investment appraisal (and if necessary my free Paper FM lectures on investment appraisal with tax) I do explain all of the above with examples.
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