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

  • This topic has 3 replies, 3 voices, and was last updated 8 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • May 28, 2016 at 2:26 pm #317731
    luckey
    Member
    • Topics: 21
    • Replies: 24
    • ☆

    Q. Victory Co is considering the purchase of new equipment which would enable the company
    to expand its operations. The equipment will cost $1.2 million and have a three?year life, at
    the end of which it will have a scrap value of $600,000.
    The equipment will mean Victory requires further factory space at an annual rental of
    $80,000, payable in advance, with the first payment being made on the day the equipment
    is purchased.
    Further annual fixed costs charged to the project will be $715,000 in total. Amongst other
    things, this includes:
    ? $86,000 of bank interest payable on the loan to cover the cost of the equipment.
    ? $74,000 of costs allocated out of head office overheads.
    ? A depreciation charge for the new machinery that has been calculated using the
    straight?line method over the life of the machine.
    Additional annual sales are expected to be 60,000 units per annum in each of the three
    years. Each unit will sell for $40 and has a variable production cost of $25.
    A further investment of $340,000 will be required for working capital. This will need to be
    in place at the start of the year. This will increase to $400,000 in the following year and
    $450,000 in the year after that. This working capital investment will be fully recovered at
    the end of the project.
    If Victory Co buys the new equipment it can claim tax?allowable depreciation on the
    investment on a 25% reducing balance basis. The company pays taxation in the year to
    which it relates at an annual rate of 30%. Victory Co uses a cost of capital of 10% per
    annum for appraising its investments.
    Ans:

    Sales (60,000 × $40) 2,400 2,400 2,400
    Variable costs (60,000 × $25) (1,500) (1,500) (1,500)
    Fixed costs (W1) (355) (355) (355)
    Rent (80) (80) (80)

    Net operating cash flows (80) 465 465 545
    Tax (140) (140) (140)

    sir, in the answer sheet there is
    (The timing of the tax cash flows must be carefully considered. Although the first rent
    outflow of $80k is showing at T0, the tax effect of this i.e a $24k tax saving appears at
    T1 and will continue for the next 3 years, until T3.)

    why is tax 140 in all 3 year ?

    May 28, 2016 at 4:35 pm #317766
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    It is difficult for me to answer fully without seeing the whole of the answer – you have clearly only typed part of it.

    It would appear that they have dealt with tax in the way that I do in my free lectures (which is the easiest way).

    They have calculated the operating profits (465 per year, which presumably you are happy with).
    Then they show the tax on the operating profits (465 x 30% = 139.5, rounded up to 140 per year).

    What you have not typed is that they will then continue and the tax saving as a result of the capital allowances, before calculated the total net cash flow each year.

    I really do suggest that you watch my free lectures on investment appraisal with tax where I work through an example explaining in detail how we deal with the tax.

    (Our free lectures are a complete course for Paper F9 and cover everything needed to be able to pass the exam well.)

    May 20, 2017 at 6:13 pm #387148
    mktaguba
    Participant
    • Topics: 1
    • Replies: 4
    • ☆

    Hi John,

    The taxable cash flow for year 3 is 545. From what I understand, the 30% tax would be applicable to the year it relates to which means tax in year 3 should be 163.5 (545*0.3). Why is it 140 in the answer?

    Thanks,

    Maria

    May 20, 2017 at 7:57 pm #387164
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    But I answered this in my previous post!!!

    Have you watched my free lectures (and read my previous post)?

  • Author
    Posts
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