- This topic has 10 replies, 2 voices, and was last updated 3 years ago by
.
- Posts
Sir, I want to keep my question short. But I’m confused related to the following line.
“Tax is payable at 30%, one year in arrears”
Reason of confusion is that in 1 question with the same line they are taking the value of tax in year 1
But in another question they are taking it’s value in year 2.
For your reference 1st question is understanding 6 of chapter 4 of kaplan & 2nd question is understanding 1 of chapter 5 of kaplan text book. I’m also copy and pasting those questions for your time saving below this line.In the following question we are taking the value of taxpayable in year 1.
Question:: An asset is bought for $10,000 and will be used on a project for four
years after which it will be disposed of. Tax is payable at 30%, one year
in arrears, and tax-allowable depreciation is available at 25% reducing
balance.
Required:
(a) Calculate the tax-allowable depreciation and hence the tax
savings for each year if the proceeds on disposal of the asset are
$2,500.
(b) If net trading income from the project is $8,000 pa, based on your
answer to part (a) and a cost of capital of 10%, calculate the NPV
of the project.But in the following question they are taking value of tax payable in year 2.
Question::Walshey Co has already decided to accept a project and is now
considering how to finance it.
The asset could be leased over four years at a rental of $36,000 pa,
payable at the start of each year.
Tax is payable at 30%, one year in arrears. The post-tax cost of
borrowing is 10%.
Required:
Calculate the net present value of the leasing option.I’ll really appreciate for the quick response.
As in the Q1: trading income from the project is $8,000 pa which will start from Y1. If the tax is payable in arrear then why it is not recorded in Y3 ? Because our 1st income is on Y1 (not in Y0).
I’m very confused.
There is no need to ask for a quick response – we aim to answer questions within 24 hours and I always answer faster than that (but we do not sit permanently in front of the computer 🙂 )
I do not have the Kaplan books – only the BPP Revision Kit.
Time 0, time 1 etc and not years. They are points in time that are 1 year apart.
So time 0 is the start of the first year
Time 1 is the end of the first year / start of the second year
Time 2 is the end of the second year / start of the third year
and so on.Tax is calculated at the end of the accounting period, and if tax is one year in arrears then the tax flow is one year after the end of the accounting period.
If the machine is bought on the first day of an accounting period i.e. time 0, then the first TAD is calculated at the end of the year (time 1) and the tax saving occurs one year later (time 2).
If the machine is bought on the last day of an accounting period (i.e. time 0) then the first TAD is calculated immediately (time 0) and the tax saving occurs one year later (time 1).
We always assume that revenue occurs on the last day of the accounting period (unless specifically told different). Therefore the first income occurs at time 1 and the tax flow occurs one year later at time 2.
I do suggest that you watch my free lectures on investment appraisal with tax (and the lectures on lease and buy), because all of this is explained in my lectures. They are a complete free course for Paper FM and cover everything needed to be able to pass the exam well. If you watch the lectures then you do not really need a Study Text – the book that is essential if the Exam Kit because it is full of past exam and other exam standard questions for practice, and practice is vital to passing the exam.
Everything is cleared Sir. But just adding one more thing in your answer to clear my concept please.
“”
We always assume that revenue occurs on the last day of the accounting period (unless specifically told different). Therefore the first income occurs at time 1 and the tax flow occurs one year later at time 2
“”But Sir, let’s assume, revenue occurs on the last day of the accounting period (T1) & tax flow will occur one year later at (T2) but as the question is specifically saying that “tax is payable in arrear” then why we are not delaying it for 1 more year ?
Thanks in advance sir. Your previous answer was too logical. Appreciate
If the tax was not paid in arrears then it would be paid immediately, so a flow at time 1 would result in a tax flow at time 1.
If it is paid one year in arrears then a flow at time 1 results in a tax flow at time 2.
Sir, please correct me if i’m wrong.
(Assuming tax is payable in arrear)
Example (i) In case of Asset purchase. (start of year)
investment = T0
TAD = T1
Tax paid = T2(Assuming tax is payable in arrear)
Example (ii) In case of Asset purchase. (end of year)
investment = T0
TAD = T0
Tax paid = T1(Assuming tax is payable in arrear)
Example (iii) In case of income – (Start of Year)
Investment = T0
Income= T0
Tax paid = T1 ?(Assuming tax is payable in arrear)
Example (iv) In case of income – (End of Year)
Investment = T0
Income= T1
Tax paid = T2 ?(Assuming tax is payable in arrear)
Example (v) In case of tax relief – Lease payment – (Start of Year)
Lease payment = T0
Tax relief = T1 ?(Assuming tax is payable in arrear)
Example (iv) In case of tax relief – Lease payment – (End of Year)
Lease payment = T1
Tax relief = T2 ?I’m more concerned about last 4 examples please…
They are all correct except for example (v).
The lease payment is at time 0. The tax relief is at time 2 (because the lease payment reduces the profit that is calculated at the end of the year which is time 1, and the tax effect is one year later at time 2.
Have you watched my lectures on lease and buy?
Yes sir, i watched a video on lease vs buy.
And the answer is beautifully explained by you. Thanks sir.Now understood fully. Thanks sir. And it will be my last question for this post. Just to make sure, i’m not doing any mistake. In the last examples i assumed “tax will be paid in arrear”. But in the following examples. I’m assuming “Tax is payable immediatley”.
E.g. (i) In case of Asset purchase. (start of year)
investment = T0 (year 0)
TAD = T1 (year 1)
Tax paid = T1 (year 1)E.g. (ii) In case of Asset purchase. (end of year)
investment = T0 (year 0)
TAD = T0 (year 1)
Tax paid = T0 (year 1)E.g. (iii) In case income received. (in start of year)
Investment = T0 (year 0)
Income= T0 (year 1 – as it is assumed revenue will be generated 1 year after investment)
Tax paid = T0 (year 1)E.g. (iv) In case income received. (in end of year)
Investment = T0 (year 0)
Income= T1 (year 1)
Tax paid = T1 (year 1)E.g. (v) In case of Tax Relief (Start of Year)
Lease payment = T0 (year 0)
Tax relief = T0 (year 1)E.g. (vi) In case of Tax Relief (End of Year)
Lease payment = T1 (year 1)
Tax relief = T1 (year 1)I’ll be full clear after it’s answer sir.
Thanks again for your support.
- The topic ‘NPV Tax Payable Period’ is closed to new replies.