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Hi, there are two more queries.
(1) As you have mentioned that tax saving derive from the capital allowance (25% of investment cost) based on tax rate at 25%, how the remaining 75% elements are treated? Is it deferred tax payable and changes at each year end until the machine is sold at year 5? It is because the scenario does not give the length of project life and I assume that it will continue to proceed after 5 years.
(2) In case the machine proceed is $300 instead of $1000, there would be negative figure of $270 in the balancing figure. As the positive figure regard as profit and hence a tax charge would levy on it. How is such situation be treated? Is it treated as tax relief (cash inflow) of $67.50?
(1) A DCF can’t be performed on half a project otherwise you would have brought in all the up-front costs but only some of the later income so the NPV would be distorted. Besides, here the project is the purchase of the machine and its subsequent production of goods and you are told that the machine is expected to last 5 years – so that is the length of the project.
(2) If at the date of sale a machine had a WDV for tax of, say $2500 and the proceeds of sale were only $2000 then there is what’s called a balancing allowance of $500. This is like a ‘catch-up’ capital allowance. If tax were 20%, this BA would then have a tax effect of $100 ie tax is lowered by $100 and the $100 would be regarded as a positive cash flow, ie income.
If the proceeds were $2,800 then you have been given $300 too much capital allowances and the tax authorities would reclaim this. The tax cash flow effect would be $300 x 20% = $60, an outflow.
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