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Sir in this question in estimating Arthuro Co’s forecast dividend capacity through FCF equity method why they have deducted profit on disposal of NCA? Profit on disposal of NCA does not come in FCF equity?
The dividend capacity is the cash that is available for dividends.
The profit on disposal is not cash, which is why it has been subtracted. It is the proceeds that are cash and so that has been added.
If I am following below format for dividend capacity i.e
FCF equity (working 1) X
Add dividend from B co X
Less additional tax X
So deducting profit on disposal of NCA adding cash received on disposal of NCA, I should show in above format or should I show it in FCF equity working 1?
It doesn’t matter where you show it in your workings (provided, as always, they are clear for the markers).
Hi sir,
(1)
Can I know which sentence in the question that hinted that ‘the profit on disposal is non-cash element?’
Also, why is the profit for the disposal not considered for tax? Since it is a ‘profit’?(2)
Why is it that they add back ‘cash received on disposal’?
Technically speaking, if we are looking for dividend capacity, we are looking at the amount that can be distributed to the shareholders.The cash received on disposal is not the ‘actual’ profit from the disposal, it is merely the cash inflow without taking into account accumulated depreciation (the actual profit will be $5.9m).
I don’t quite understand why we only consider the cash inflow and not the actual gain of the transaction.(3)
Why is it they add back ‘depreciation’?
(I am guessing this is the TAD and because the depreciation has been deducted from the operating profit, so this step is just to add back the TAD?)Thanks in advance!
Just a bit more, sorry!
(4)
Why is it that for the (a)(ii), the number of shares, the answer did 90m x 4/3?It said one-for-three shares, why is it not 3/4?
(5)
In the question it said, “Hittyland gives full credit for corporation tax already paid….” and “Hittyland gives no credit for withholding tax paid on dividends…”What is this credit?
I don’t see any technical articles on this so can you please point me to the suitable material to refer to?Thank you!
1. Profit on disposal is never cash. This is a standard financial accounting procedure. The proceeds from sale are cash not the profit.
2. Cash received from disposal is added because there is more cash available for dividends.
3. Correct.
4. If it is 1 for 3 then they issue 1/3 x 90 = 30. So the total is 120 (which is 90 x 4/3)
5. This is explained in my free lectures (and is standard from Paper TX).
(1) to (4): Thank you! I can see it clearly now.
(2):
I don’t quite understand why dividend capacity only takes into account the cashflow available for distributing without considering the net profits.For instance, I have $100k cashflow, and perhaps $90k of accrued expenses.
Because I indeed have not paid for the expenses, I still have a cashflow of $100k.In this case, is it sensible to consider that my dividend capacity is $100k instead of the $10k profit? My point is that had I really distributed full $100k as dividends to shareholder, I won’t have any funds left to pay my expenses.
Thank you!
The dividend capacity is the amount of cash available to pay dividends. It doesn’t mean that they will actually end up paying it all out as dividends.
The profit (and retained earnings) are a legal limit on the dividends, but it is the cash available that determines how much they can actually afford to pay.
Thank you so much!!
This answer had cleared up the doubts I had all this while.I keep thinking that it’s not sensible if, I only consider the cashflow without taking account into the net profit, when reasonably speaking, my capacity to distribute dividends would only have been $10k instead of $100k. I was not aware of the concept of ‘legal limit’.
Therefore, can I say that even though my dividend capacity is $100k, the legal limit that I can distribute dividends is actually $10k?
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