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Dear Sir,
Please help me clear a doubt I have about some parts of the answer to the financing effects of the project.
I understand the total amount of investment required is 42.97 (38 + 4.97 Year 0 working capital )
The issue costs ((2/98 *42.97)= 0.877), are on the gross amount of the funds required.
No where in the question is it stated about the source of funding for issue cost.
Doe this not suppose that the total amount of Loan raised from the two sources is
100/98*42.97 = 43.85, to include issue cost?Should this not be the amount apportioned between the subsidy and the normal Loan?
The examiner rather apportioned 42.97 between the subsidy and normal loan parts and performed the financing effects on these. This confuses me.
1. Are you able to explain the intuition behind the examiner’s treatment?
2. If there is no indication, as it is in this case, is it okay to assume that issue costs are tax allowable?
3. How about the tax benefit forgone as a result of using the subsidy, as in
4%-1.5% x (amount of subsidy Loan) x Tax Rate x 4% annuity for 4 years.? Should this just be ignored?Kind regards
Samson
The examiner has assumed that the issue costs are from other sources and therefore the interest on which there is the tax relief is only on the 42.97.
However this is an assumption – in P4 so much depends on your assumptions (as it does in real life) and provided you state your assumption you still get the marks. (The examiner should actually have stated his assumption).The answer does calculate the subsidy benefit (the 2.5%) net of tax.
Alright, that makes sense now.
But will it be the same workings where tax is paid say a year in arrears? That is where the subsidy benefit is received earlier than the tax relief on interest (as tax payment is lagged by 1 year). The BPP text book mentions this but it is not clear. Is it even worth looking at these from this angle at all? Or is it just okay to assume again that the tax benefit and subsidy benefit are all received at the same time?
Regards
If the tax is payable one year in arrears, then yes – it would affect it.
However do not worry about this in the exam. The examiner ignores the delay in his answers 🙂
(but it would be a nice thing just to mention as a note)Hi Sir,
I have a question on calculation of tax shield and financial effect of subsidized loan in Burung Co June 2014 which I would like to ask for your help as well.
In the answer to the exam question, tax shield is calculated as tax saving arise from actual interest payment
PV of Tax Shield = [($42,970,000 x 60% x 0·015 x 20%) + ($42,970,000 x 40% x 0·04 x 20%)] x 3.63I understand that if tax shield has been calculated based on actual interest payment (which based on the subsidize interest rate already) => the calculation of subsidy benefit should not net of tax (as this has been accounted for in Tax shield calculation). However, in the answer, the calculation of Subsidy benefit is:
PV of Subsidy benefit = $42,970,000 x 60% x 0·025 x 80% x 3.63
Could you help to explain which way is correct to calculate the tax shield and subsidy benefit?
Thank a lot!
Please don’t ask the same question twice!
I have answered your other posting of this question 🙂Hi John,
In Burung when calculating the tax allowable depreciation in the fourth year, why isn’t the depreciation amount of $1.125 million deducted when in the question Chmura company the depreciation of $125 is deducted?
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