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Hi John,
Please can you explain this question…I cant get my head around this please.
A co has 31 Dec as its accounting year end. on 1st of jan 20×5 new machine costing $2000,000 is purchased . The company expects to sell the machine on 31 Dec 20×6 for 350,000. the rate if tax is 30% tax allowable depreciation is obtained at 25% on reducing balance basis. the company make sufficient profits to obtain relief for tax allowable depreciation as soon as they arise
if the company cost of capital is 15% per anum what is the present value of the tax allowable depreciation at 1Jan 20×5?#
Many Thanks,
NoureenI am sorry but you are going to have to watch my free lectures on investment appraisal with tax.
I explain in detail how to calculate the tax allowable depreciation on a new machine, and how then to calculate the tax saving as a result, and you cannot expect me to type out my lectures here 🙂(I don’t know where you found this question, but if you have typed the whole of the question out correctly then the actual question at the end is stupid and would not be asked in the exam. You will not be asked for the PV of the tax allowable depreciation. What you certainly could be asked for is the PV of the tax saving as a result of the tax allowable depreciation. The question would also have to tell you whether tax was payable immediately or whether there was a one year delay in the payment of tax.)
Hi John,
Thank you for your reply. I have watched all your lectures and I’m very confident of calculating Tax allowable depreciation and tax saving on it..
This question is from Kaplan and also in BPP there is a question in the exam kit where they are asking at the PV of tax allowable depreciation.
I have copied the full question and I’m glad to hear that the chances of such a question is extremely thin.
But this type of question is also asked in BPP kit under the investment appraisal topic.
Please if you still can answer how to calculate I will appreciate that.
Many thanks,
NoureenHi John,
The question from BPP kit which is asking for the present value of tax allowable depreciation is Q105 and also the question 106 which is asking the after tax present value of perpetuity is 106..
please if you can explain those 2 as well?
Many thanks,
NoureenFirstly, as I wrote before, it would be silly to be asked for the present value of tax allowable depreciation.
What you can be asked and what the BPP question asks, is the benefit of the depreciation – again, as I wrote, this certainly can be asked. The chances of this being asked are not thin at all.Q105 only wants the PV of the tax benefit of the first portion of the TAD. The first TAD is 25% of the cost of $1M, and the tax benefit is 30% of it. So a tax benefit of $75,000.
Since the machine is bought on the last day of an accounting period, and tax is payable 1 year later, they get the benefit at time 1 and this is therefore discounted for 1 year at 10%.In Q106, the income is 20,000 p.a. from 1 to infinity and so you discount this by multiplying by 1/0.10 as usual.
The tax on the income is 20,000 x 30% from 2 to infinity (because it is payable 12 months later). You can then discount this in the normal way (multiply by 1/0.10 and then discount the answer for 1 year because the perpetuity starts one year later). Alternatively you would get the same result by multiplying the PV of the income by 30% and then discounting this for one year. It doesn’t matter which way you do it.The overall PV is obviously the PV of the income less the PV of the tax flows.
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