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Hi sir, I notice that in recent exam questions, there will be a statement stating that the “tax allowable depreciation is expected to be equivalent to the amount of investment needed to maintain the current level of operations”.
This has confused me as I read this as the TAD will be at the same amount as the working capital needed. However, in the answers they seem to totally ignore any TAD in both the calculation of tax or adding it back to the net value. Based on the Sample Mar/Jun 2018 questions & answers in the official ACCA website, the first question on Chikepe Co included this said statement in the question and totally ignored any TAD in the tax calculation in the answer given!
Several things:
Firstly, the TAD has not been ignored in the calculation of tax. The question says that in arriving at the profit before interest and tax the TAD has already been deducted (and tax is calculate after deduction of TAD).
Secondly, TAD has been added back – it is included in the $112M that has been added back (TAD and other non-cash expenses).
Thirdly, although most recent questions do state that the TAD is the same amount as the investment needed to maintain the current level of operations (and I explain the impact of that, with examples, in my free lectures), this question does not – it specifically says that the amount needed is 98.2M, and so this is the amount that has been subtracted.
Thanks for the reply. However, I am referring to the calculation of the market value of equity for the COMBINED company, which states: “The combined company’s tax allowable depreciation is expected to be equivalent to the amount of investment needed to maintain the current level of operations. However, as the company’s sales revenue increases over the four-year period, the combined company will require an additional investment in assets of $200 million in the first year and then $0·64 per $1 increase in sales revenue for the next three years.”, in which in the answer only accounted for:
1) 20% operating profit margin,
2) less off 20% tax (of the operating profit)
3) less off $200m of additional investment
to derive at the FCF of the year.What the examiner’s answer has done is perfectly correct.
– Operating profit is automatically after depreciation (this is financial accounts)
– Tax is calculated on the profit after depreciation (this is the normal tax rule)
– Depreciation is usually added back because it is not a cash flow, but here it is not added back because it is expected to be equivalent to the amount of the investment needed to maintain the current level of operations – so there is a cash outflow of the same amount as would otherwise have been added back. So no net effect.
(The current examiner is always doing this and I explain and stress this in my free lectures!)– There is additional investment of 200M, so this is subtracted as a cash outflow (as per the instruction in the question)
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