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Hi John,
this is in reference to the investment appraisal qn which appeared in the sept/dec hybrid paper. Can you please explain how the working capital is calculated ?( the 150 present at the start of the project hasn’t been included in the suggested answer calculation – why is this ) Also can u please explain why the resale value of 200,000 has been deducted from the initial investment amount when calculating the capital allowances i.e its restricted to 1.3 mn instead of 1.5mn ? in all the other qns i have attempted i have not done this but ended up with the right answer. i had a look at the suggested answer but am confused so would appreciate sure explanation..thanks
The 150,000 has not been included because the question says that it already exists (so there is no extra outflow needed at time 0)
With regard to the capital allowances, the examiner has set out the workings in an unusual way but the figure is correct.
The balancing allowance is the difference between the tax written down value (the initial cost less the allowances each year) and the sale proceeds. (The total allowances as a result are always equal to the difference between the original cost and the sale proceeds.)
It might help you to watch our free lecture on Investment appraisal with tax.thanks john for the reply. i have done questions from the kaplan study guide and in all instances i have not deducted the sale proceeds from the original cost when calculating capital allowances..it has always been on the original cost and my answer matches kaplans answer although i use a different method – how is this possibe ? I got stuck on this question because of the working capital adjustment..
I do not think that you read my previous reply properly!
The balancing allowance/charge is arrived at by taking the difference between the sale proceeds and the tax written down value. This is always the case – it is the case in all of the Kaplan questions and in the exam questions (including this one).
In this answer the examiner wrote the figures in a different order, but the end result (which is all that matters) is exactly the same.
I don’t know whether or not you sat Paper F6 (UK) but the whole reason for having a balancing allowance or balancing charge, is that in total the allowances should be the same as the difference between the cost and the sale proceeds. If you did take F6 (UK) then this should have been explained to you 🙂
Hi john, under what circumstances do we recover the working capital at the end of the project? If u look at the June 2011 paper the qn doesn’t explicitly state wc is recovered at the end of the project but in the suggested answer it has been recovered..but in the sept/ dec hybrid paper it has not been recovered( qn is silent again)..pls clarify its doing my head in!!! Thanks
If the machine is just for one-off production, then the working capital is recovered at the end of the project.
If, on the other hand, the machine will be replaced at the end of its life (as is the case in this question), then you assume that production will continue and therefore the working capital will still be needed (and is therefore not recovered).
Last qn regarding wc ( promise!)..if the qn says the machine is just for one off production but there is some existing wc and this will increase in line with general inflation, do we recover only the incremental wc or the existing wc as well?
Hi john, if wc is to be recovered at the end of the project and there is existing wc before the project begins ( as in the sept/ dec paper) do we show the existing wc as an outflow ?
If there is already working capital existing, then there is no outflow because it is already there.
we don’t show the existing wc as an outflow but when recovering we recover the existing wc plus the incremental – is that right?
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