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In section c (ii) the question asks you to calculate the sensitivity of the investment in the new machine to a change in selling price.
In the answer they calculate the present value of sales rev and then minus the tax- but before they minus the tax they discount it for one year. Now the tax is paid one year in arrears- but why are we discounting it by one year, shouldn’t we work out the annuity factor and then minus the one discounted year?
Thanks for all your help
You can do it either way and the answer will be the same (apart possibly a rounding difference, but rounding does not lose marks in the exam).
If (for example) there is an annuity from years 2 to 5 then the two ways are either:
Take the 5 years annuity df and subtract the 1 year annuity.or
Multiply by the 4 year annuity df (because there are 4 years of flows) and then multiply by the normal 1 year df (because the annuity starts 1 year later).
Again, apart from possible rounding differences in the tables, you will end up with exactly the same answer.
i also have same issue , same question warden dec 11 Q1
project 5 yrs .. . tax one year in arrears.
PV of sales 1600 x 3.696 (5yrs) = 5913.6
tax 1600 x .3 = 480 x3.33 (annuity 6 -1 ) =( 1598.4)
=4315.2
this one correct ?
examiner answer
The PV of sales revenue = 100,000 x 16 x 3·696 = $5,913,600
The tax liability associated with sales revenue needs be considered, as the NPV is on an after-tax basis.
Tax liability arising from sales revenue = 100,000 x 16 x 0·3 = $480,000 per year
The PV of the tax liability without lagging = 480,000 x 3·696 = $1,774,080
(Alternatively, PV of tax liability without lagging = 5,913,600 x 0·3 = $1,774,080)
Lagging by one year, PV of tax liability = 1,774,080 x 0·901 = $1,598,446
After-tax PV of sales revenue = 5,913,600 – 1,598,446 = $4,315,154
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