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Hi John, in (c) (i), they have calculated tax on 192.3, but shouldn’t tax be calculated after interest on (192.3-78.6)
In the same question, why haven’t they discounted by one year, as doesn’t the perpetual value be for “Year 1 and onwards”. Therefore for PV, they would need to discount by one year right?
We always ignore interest when arriving at the cash flows (whether in this sort of question or whether in standard project appraisal) because the discounting is taking account the after-tax cost of interest.
Using the growth formula is discounting a perpetuity that starts in 1 years time. We would only need to discount for an extra year if it started in 2 years time.
But in Lirio (Mar/Jun 16), they have reduced interest from Operating profit, then only calculated taxation
I don’t know which part of Lirio you are referring to. In profit statements we always calculate the tax after the deduction of interest because interest is tax allowable.
When discounting to value a business, depending what the question requires we either discount the cash flows before interest at the WACC to get the total value of the business (equity plus debt), or we discount the cash flows after interest at the cost of equity (as in Lirio) to get the value of the equity.
In the first case we ignore interest and the tax saving on the interest (and therefore the tax is calculated on the profit before interest) because we are discounting at the WACC. In the second case we get the cash flows after interest and calculated the tax on the flows after interest.
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