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1. Do we always use purchasing parity theory for calculation of exchange rates adjusted with inflation ?
2. In order to determine taxable cash flows we subtract tax allowable depreciation first. But in Dec 2003, AVTO (found the question in Kaplan question paper), it was not done. Why so?
1. If you need to calculate future spot rates, then yes – you use the PPP formula.
2. I do not have the Kaplan book (only BPP) but I do have the original exam question 🙂
There are two ways of dealing with tax allowable depreciation (that both give the same final result, which is all that matter for the exam).
One way is to subtract the depreciation, the calculate the tax (on the profit after depreciation) and then add back the depreciation (because it is not a cash flow).
The other way (and the way in this examiners answer) is to calculate the tax on the operating profits before deprecation, and then separately calculate the tax saving on the tax allowable depreciation.Again, either approach is fine -the final cash flows will be the same.
If you are still unsure, watch my free Paper F9 lectures on investment appraisal with tax, because this is revision of Paper F9.
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