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Purchase the machine at$1800,000 payable on 1 Jan 20×1. After this project machine could be sold for $240,000 receivable on 31 Dec 20×4
What is present value of tax allowable deprecation for second year under option 1?
Tax allowable depreciation @ 25% and Corporation tax rate: 20%, after tax borrowing 10% and before cost of capital 8 %
I calculated Tax allowable depreciation:
year 0-1800000
Year-1,Tax @ 25% (450000)=1350000
Year-2, Tax @ 25% (337500)=10125001012500*0.826=PV 836325
what is my mistake here? Please help.
I don’t know where you found this question, but if you have typed it exactly as it was written then it is a silly question.
You will never be asked in the exam for “the present value of the tax allowable depreciation” – it would be meaningless.
What you certainly could be asked is “the present value of the tax saving due to the tax allowable depreciation”.Assuming that the depreciation is reducing balance (sometimes it is straight line – but exam questions always tell you) then your depreciation calculations are correct, but the tax saving would be 20% of those figures.
Also in the exam you will be told whether tax is payable immediately or with a one year delay. If it is payable immediately the you discount the 1012500 x 20% for 2 years. If there is a one year delay then you discount it for 3 years.
Finally, “After tax borrowing 10% and before cost of capital 8%” makes no sense at all. You would normally discount at the weighted average cost of capital, but this would be higher than the after tax cost of borrowing.
Does your book not show workings with the answers?
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