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S Co has a 31 Dec year end and pays corporation tax at a rate of 30%, 12 months after the end of the year to which the cash flows relate. It can claim tax allowable depreciation at a rate of 25% reducing balance. It pays $1m for a machine on 31 December 20×4. SW CO’s cost of capital is 10%.
What is the present value on 31 Dec 20×4 of the benefit of the first proportion of the tax allowable depreciation?
Sir in this question they are taking tax allowable depreciation at First year but in normal case the tax will come on 2 nd year when we connect to the lease rentals could you explain thiss
The tax benefit is realised in the following year (20X5) due to the one-year delay in tax payment. Therefore, the present value of the tax saving is discounted back to 31 December 20X4 using the cost of capital.
So:
To claim tax allowable depreciation instantly when they bought the asset.
$1,000,000 * 25% = $250,000.
Since tax is not payable for a year relevant amounts have to be discounted.
Corporate tax rate of 30% so therefore tax saving $250,000 * 30% = $75,000
This has to be discounted to show value at end of 20X4 that is 75,000 / (1 + 10%) = $75,000 / 1.10 = $68,181
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