Question 165 revision kit — OpenTuition Forums

TTruc5y ago

Dear Sir, The initial investment costing $25 million. The terminal value at the end of the 4th year is of 5% of the initial investment cost. The company can claim tax-allowable depreciation on a 25% reducing balance basis. Co pay corporate tax of 30% 1 year in arrears. I think 1st year tax saved on capital allowance = [25 million - (5% of 25 million)] *25% *30% = $1,781,250. But the answer is [25 million *25% *30%] = $1,875,000. I don't know why we should not subtract the terminal value (as scrap value) from the initial investment before applying 25% reducing balance? Please advise!!! Thank you so much!!!

John MoffatTutor5y ago#1

We never subtract the terminal value from the initial investment when using reducing balance depreciation. We never do that in financial accounting and we certainly never do that when calculating the tax allowable depreciation. I do suggest that you watch my free lectures on investment appraisal with tax.

TTruc5y ago#2

I have watched all of your lectures and yes, you didn't subtract it when using reducing balance depreciation. I think you also didn't mention about terminal value. Actually, I only have the revision kit and your Note, I don't have any Study text so I don't know what terminal value is, and its role as well as whether to use it in any calculation in FM subject or just ignore it. I just guessed from its name that it's the final value of the project. I'll do some research. Thank you!!!

John MoffatTutor5y ago#3

"Terminal" means "End", so the terminal value is the value at the end of the projects life. So you are correct in thinking it is the final value of the project. However this is still of no relevance whatsoever for the calculation of the tax allowable depreciation for the reasons I explained in my previous reply. I explain this in my free lectures and in my free lectures for Paper MA (was F2) because the expression 'terminal value' is revision from Paper MA.

TTruc5y ago#4

Thank you.I was exempted from F2 many years ago so I don't remember much. I'll watch your F2 lectures. I have this concern which is not relating to this question. But this will be my computer- based exam after many years. I am afraid I'm gonna lose some marks since MCQs will be marked by the computer, not examiner I think. Like in question 121 Revision Kit, their answer is $11,100. But my answer is $11,000 because on the question said "to the nearest $100". So I am confusing why their answer is still $11,100 without rounding to the nearest $100 as the question asked. If this question asked "to the nearest $" so I think $11,100 is correct but it's not the case here. Am I right?

John MoffatTutor5y ago#5

No. To the nearest $100 means it must end in $100's, so $11,100 is correct. If it asked for it to the nearest $1,000 then the answer would be $11,000.

TTruc5y ago#6

Hi John, so terminal value is just the worth of the investment after a specific period of time. It's not Cash flow. so why we take it into account to calculate the total CF as like in this Q165? Thank you so much!!!

John MoffatTutor5y ago#7

It is treated as a cash flow because that is what it is worth at the end of 4 years.