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PV with taxation and perpetuity

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › PV with taxation and perpetuity

  • This topic has 6 replies, 4 voices, and was last updated 1 year ago by LMR1006.
Viewing 7 posts - 1 through 7 (of 7 total)
  • Author
    Posts
  • December 26, 2020 at 6:06 pm #600922
    leo10
    Member
    • Topics: 36
    • Replies: 18
    • ☆☆

    Hi Sir,

    Would you please help me on the following.

    A project is expected to generate pre-tax income of $90,000 per annum, starting in one year
    and running in perpetuity. Tax is payable 12 months in arrears at 20%. The after tax cost of
    capital is 8%.
    What is the PV of the project flows?

    The solution is 917,000 but I am not clear on how to get to this result.

    Thank you

    Leo

    December 27, 2020 at 10:58 am #600949
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    The PV of the pre-tax inflows is 90,000 / 0.08 = 1,125,000.

    The PV of the tax outflow on these flows is 20% x 1,125,000 x 1/1.08 (to discount for one extra tear because of the tax delay) = 208,333

    Therefore the PV of the net flows is 1,125,000 – 208,333 = 916,667

    December 27, 2020 at 2:20 pm #600970
    leo10
    Member
    • Topics: 36
    • Replies: 18
    • ☆☆

    Thank you for this. One more thing please I am not entirely clear.
    It seems when we discount for one year we divide by 0.08. Instead when we discount for one extra year we divede by 1.08. If we were to discount for two extra years (instead of one) would we divide by (1.08)*(1.08)?

    Thank you

    December 27, 2020 at 3:28 pm #600983
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    We divide by 0.08 because it is a perpetuity and the discount factor for a perpetuity is 1/r.

    The tax flows are a perpetuity as well but they start 1 year later and to we divide by 1/1.08 to discount for one extra year. If the tax flows started 2 years later the we would divide by
    (1/1.08)^2 to discount for two extra years (although it would be quicker to use the tables provided).

    I do suggest that you watch my free Paper MA lectures on Chapter 25 of the Paper MA lecture notes in addition to watching my free Paper FM lectures, because this is very basic discounting.

    November 30, 2023 at 11:59 am #695759
    iris640
    Participant
    • Topics: 0
    • Replies: 1
    • ☆

    Hello John, Leo,

    I’m having trouble understanding why do we use the post-tax discount rate of 8% to calculate the PV of pre-tax inflows of 90 000. Isn’t a rule to use the pre-tax discount rate for a pre-tax inflows?

    November 30, 2023 at 4:37 pm #695769
    LMR1006
    Keymaster
    • Topics: 4
    • Replies: 1511
    • ☆☆☆☆☆

    Always use an after-tax rate for investment appraisal
    or
    Always use the after-tax WACC when appraising investments
    or
    Use a post-tax money discount rate

    It’s in our excellent video, notes and in your textbook

    November 30, 2023 at 4:37 pm #695770
    LMR1006
    Keymaster
    • Topics: 4
    • Replies: 1511
    • ☆☆☆☆☆

    Always use an after-tax rate for investment appraisal
    or
    Always use the after-tax WACC when appraising investments
    or
    Use a post-tax money discount rate

    It’s in our excellent video, notes and in your textbook

  • Author
    Posts
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