MARCH 2020 q2b

If you start with operating profit, that is before interest and tax. To get to NOPAT you have to take off tax, but tax before any allowance for tax relief on interest because NOPAT is before interest. When adjusting the tax charge to what it would be before interest the adjustment needed is the rate relief on interest, so 22% x 1,500.

If you start with PAT, tax and interest have been deducted. You have to adjust for the interest, but the amount to be added back must adjust for the corresponding increase in tax because if there is no interest there is no tax relief in interest. Therefore the effect is to add back 78% of interest.

Yes. You started with the pre-tax figure so at some point have to deduct tax…..but that has to be what the tax would have been without interest effects. For example, if tax is 25%

OP = 1000
Int = 200
PAI = 800
Tax = 200
PAT = 600

To get NOPAT, either start with OP or PAT

OP = 1000. Tax on that @25% = 250. NOPAT is 750. Or, for tax, take the 200 charge and say that that had been reduced by tax at 25% on the interest, so the tax before interest is 200 + 200 x 25% = 50. Tax charge before interest is therefore 200 + 50 = 250, as before.

Starting with PAT of 600 tax is already deducted, but so is interest. If interest of 200 were simply added back then the figure is 800. However, if you iwant the pre interest figure you also have to take into account the tax on the interest, and the tax relief on the interest would be lost. Therefore, adding back interest is modified to add back 200(1 – 0.25) = 150. Or add back all the interest of 200 then increase tax by 25% of 200….net effect 150. NOPAT is therefore 600 + 150 = 750, as before.

Op profit = 10,000 (this is before interest and tax, so for NOPAT, appropriate tax has to be removed). Also certain adjustments are needed – for example, advertising.

Tax on OP @ 22% = 2,200

NOPAT, before adjustments = 10,000 – 2,200 = 7,800

Adjustments: R&D to be added back to profit; Change in doubtful debts not allowed as an expense/nor treated as income if reduced. So + 450 – 200 = +250

7,800 + 250 = 8,050

Because you are calculating tax directly here: 22% of OP.

Interest and its tax relief does not need to appear anywhere.

In that question tax was not calculated directly as 25% of OP.

In the adjustments to get to NOPAT, tax paid was taken off, but this was lower than it would have been if it had been calculated before interest had been deducted. The interest charge was 23 and the tax relief on this was 25% x 23 = 5.75. Tax on operating profits (before interest) means also before tax relief on the interest. The tax charge on OP must therefore be increased by 5.75.

I really have no more to say on the issue of tax relief adjustments for NOPAT. All explanations have been exhausted. You need to go away and think carefully about the process, looking through examples in the notes, lectures and above.