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Hello, i have a question related to question (b) about the suggested measures given by the owner.
For the npv part, in the given answer, the examiner has calculated tax first then added back the depreciation to each of their relevant years. My question is why?
Depreciation is a non cash-item, it should be added back to profit to convert it into cash flows, but isnt it the same for tax purposes?
By doing so, the examiner means depreciation is allowable for tax deductions?Note 5 says that accounting depreciation is a tax allowable cost. It will decrease the tax bill, but it is not a cash flow so has to be added back.
if this was not said then we should have added back depreciation 1st then calculate the tax?
If you are going to use NPV you must ignore interest flows and any tax relief on those flows. Discounting handles interest.
For 2010, the profit before interest and tax is $31,200. Ignoring interest, this will be taxed at 30%, leaving profit after interest of $21,840. (Note, depreciation is allowable for tax)
However, the depreciation amount of $120,000 is not a cash flow (depreciation never is), so the free cash from the operating cash flows is $21,840 + 120,000 = $141,840
How did the examiner got the following Pv@12.5%?
2010 $ 179,516
2011 $ 292,169
2012 $ 303,626
Please help.I would ignore that – it is a really peculiar, once-off calculation and it is not worth investing valuable time in.
Look instead at the tutor note right at the end of the question.
Sir, two things:
Firstly, why do we use the cost of capital as WACC whereas we have the mix of capital (250k equity and 350k debt) and their relative costs to calculate WACC, is it because the question says ‘Overall Cost of Capital’ as a synonym for WACC, “overall” being the key word here?
Secondly, Why does the marking scheme and the revision kit answer both have a table calculating PAT for all three years where the first two years are clearly not relevant anywhere in the question, am I missing something here?
You need market values for WACC and I don’t think we have those.
EVA is calculated only for the latest year. The other figures are used for the NPV calculation.
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