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Sir, I am facing a problem understanding the assumptions used in discounting when calculating NPV. Can you please explain to me!
1) All Cashflows occur at the start or end of a year
2) Other Cashflows start one year after that (T1)Thanks in advance
Although in real life cash flows can occur at any time during an accounting period, we only discount for yearly periods. We therefore assume that operating flows occur at the ends of accounting periods unless specifically told otherwise. I do explain this in my free lectures on investment appraisal and why it is sensible in that it is taking a ‘pessimistic’ view.
Time 0 is a point in time and is the start of the first year and the time when the initial investment occurs.
Time 1 is a point in time that is one year later. It is the end of the first year / start of the second year.Again, do watch my lectures because I do explain all of this.
Thanks for your reply 🙂 I did watch your lecture now & this is what I understood. Please correct me if I get this right.
I have two more queries related to your answer regarding Taxation & Capital Allowance.
As regards to taxation, that tax is paid one year after the operating cashflow is earned which is at Time 1 unless told otherwise like when tax is in arrears then it would be paid two years after which is at Time 2. [Please correct me here?]
As regards to Capital Allowances, we assume that asset is purchased on the first day of the accounting period at Time 0 and that the first amount of capital allowance occurs one year later at Time 1.
BUT I have a problem understanding that why do capital allowance occurs two years later at TIme 2 when the tax is also in arrears regardless of when the asset was purchased at Time 0. [Please correct me here also?]
It tax is paid one year in arrears then the tax on an operating flow that occurs at time 1 will be payable at time 2.
If an asset is purchased on the first day of an accounting period (time 0) then the capital allowances are calculated at the end of the accounting period (time 1), as per normal Paper TX rules. If the tax is one year in arrears then the first capital allowance saving is one year later which is time 2.
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