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Kit question

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Kit question

  • This topic has 5 replies, 2 voices, and was last updated 1 year ago by John Moffat.
Viewing 6 posts - 1 through 6 (of 6 total)
  • Author
    Posts
  • April 24, 2021 at 1:56 am #618646
    ilham9089
    Member
    • Topics: 236
    • Replies: 171
    • ☆☆☆

    Juicy Co is considering investing in a new industrial juicer for use on a new contract. It will cost $150,000
    and will last 2 years. Juicy Co pays corporation tax at 30% (as the cash flows occur) and, due to the health
    benefits of juicing, the machine attracts 100% tax-allowable depreciation immediately.
    Given a cost of capital of 10%, what is the minimum value of the pre-tax contract revenue receivable in two
    years which would be required to recover the net cost of the juicer?

    Hi sir, could you please explain this question?

    April 24, 2021 at 8:32 am #618685
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51563
    • ☆☆☆☆☆

    The minimum value of the receipt in 2 years time is whatever will end up making the NPV of the investment equal to zero.

    So let the pre-tax revenue at time 2 be X. Calculate the NPV of all the flows (in terms of X) and then use simple algebra to find out what value of X makes the NPV equal to zero.

    April 25, 2021 at 5:15 am #618775
    ilham9089
    Member
    • Topics: 236
    • Replies: 171
    • ☆☆☆

    Okay so I understand the rest but I’m confused how the tax allowable depreciation is reducing the cost of the investment in this question. I mean they act as tax savings so they will reduce the tax but why do we remove the whole 45000 from the investment?

    April 25, 2021 at 8:36 am #618801
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51563
    • ☆☆☆☆☆

    The tax allowable depreciation is 100% x $150,000.
    This means that the taxable profit is reduced by $150,000 and they will save tax of 30% x $150,000 = $45,000.

    Paying less tax of $45,000 is a saving and therefore effectively an inflow.

    Have you watched my free lectures on investment appraisal with tax?

    April 25, 2021 at 7:34 pm #618837
    ilham9089
    Member
    • Topics: 236
    • Replies: 171
    • ☆☆☆

    Yes sir I have. I meant wouldn’t they first act as a tax saving and when they fully cover the tax expense THEN reduce the cost of the investment?

    April 26, 2021 at 7:04 am #618859
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51563
    • ☆☆☆☆☆

    They never reduce the cost of the investment.

    Tax allowable depreciation reduces the taxable profit and therefore saves tax.

    We always assume that the company is already making lots of profit and is therefore paying lots of tax. So the the capital allowances on the new investment will reduce the existing profit of the company, therefore mean less tax payable, and therefore result in a tax saving.

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