Capital allowances Sleepon question

It is not that you are missing anything, but it is partly down to assumptions and partly down to very odd wording in the question. The odd wording was that the examiner (and it is a very old question - the examiner has changed two times since!) did not say that there was a 1 year lag in tax, but said that there was a 1 year lag in the capital allowances. I have not got BPP's book, but I would assume that their answer does the same as the examiners own answer. He treated that tax itself as payable immediately (so the first income is in year 2 and the tax on it is dealt with in year 2 as well). Also, because the park was working in the second year, he first gave the tax benefit on the allowances in year 2 also. It is very much down to assumptions (as is so much of all NPV question in Paper P4). Provided you state your assumptions (and they are sensible) then you will still get the marks even though the final NPV will be different. There is rarely just one correct answer at P4.

From my book: The theme park would cost a total of $400m and could be constructed and working in one year's time. Half of $400m would be payable immediately, and half in one year's time. $250m of the investment will attrackt 25% per year capital allowances on reducing balance basis, available with a one year lag. Even if allowances are with a year lag they should appear in year 3 and tax benefit too. And capital allowances should not be included in the 4th year of business if non current asset is sold at that year. (or here again have to use some assumptions that asset is sold at the first dates of next year?)

The building was completed after 1 year. He has simply assumed that you are therefore entitled to the allowances in the first year year, but with a 1 year lag that makes the benefit at time 2. However, as I said before, it depends on what assumptions you make. Provided you state your assumptions it really does not matter at all whether you start the allowances at time 2 or time 3. With regard to the final allowance, it fits in the the assumption he has made about the first allowance. He assumed that the first allowance was given at the end of the first year (even though the park didn't start operating until the second year) and with one year lag, we got the benefit at time 2. The benefit for the second year (the first year the park actually started operating) we get at time 3. The benefit for the third year (the second year of operation) is got at time 4. The benefit for the fourth year (the third year of operation) is got at time 5. As you rightly state, there are no allowances in the year of sale of the park - i.e. the fourth year of operation. (If he has not said that the realisable value was after tax, then there would have been a balancing charge or allowance - this would have been at time 6). I know it is a bit confusing - usually if a project lasts for 4 years you will expect to get allowances for 3 years (and a balancing charge/allowance is the 4th - but not relevant here). The problem here is that due to first assumption, they are also getting allowances for the year before it starting operating - so allowances for 4 years.

Hard to digest, but I will try to make assumptions when I will see confusion. Thank you John for such a detailed explanation :)

You are welcome :-) (and yes - whenever you are unsure about anything, or if the question does not make it clear, then make sure you state your assumption. You will still get the marks (unless, of course, the question had made it clear but you have missed it - although even then they will still give some credit rather than no marks at all!!)

Hi sir, Why in this question do we add capital allowance to expenses to get taxable cash flow and after that add back only the tax saving on CA to after tax cash flow. I thought there r two ways to calculate after tax cashflow which is: 1. Do not include capital allowance when calculate taxable CF and add only tax saved on CA. 2. Include CA when calculate taxable CF and after tax adjustment add back CA since it is not a cash flow. Correct me if I'm wrong

I don't know which answer to Sleepon you are looking at. However the examiners own answer does it the way you have written as method 2. He has subtracted CA's in arriving at the taxable profit (by including them as an expense), then calculated the tax, and then added back the CA's because they are not a cash flow. BPP's answer uses the method you have listed as method 1, and they arrive at exactly the same final result.