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Dear sir, I have a question related to the following:
A company purhcased an asset for $1 m on 31 Dec 2014. The company pays corporation tax at a rate of 30%, 12 months after the end of the year to which the cash flows related. It claim tax allowable depreciation at a rate of 25% reducing balance. What is present value of the benefit of the first portion of tax allowable depreciation (cost of capital is 10%)?In the book, tax allowable depreciation is claimed in 2014 and the present value is therefore 0.25*0.3*0.909 = 0.068. Is it right?
I think the first portion can be claimed at the end of 2015 and the benefits will affect the cash flows of 2016 (after 12 months as tax is paid on the profit of the previous year).Thank you in advance.
Assuming that the companies year end is 31 December each year, then since the purchase was on 31 December 2014 (time 0) then the allowance will be calculated as at 31 December 2014, and the tax affect will be one year later (i.e. time 1).
So the answer in your book is correct – the allowance is 25%, the tax saving will be 30% of this, and it needs discounting for 1 year.
(If you are worried as to the fact that the new machine is obviously unlikely to have made any profits in the year to 31 December 2014, then remember that we always assume that the company is already making plenty of profit elsewhere and therefore the allowances will be set off against existing profits and therefore will result in a tax saving)
Thank you for your reply.
I just thought that we can’t claim tax allowable depreciation in 2014 because the asset was purchased on 31 Dec 2014. So no time in 2014 falls on the useful life of the asset.
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