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tax working in investment apprisal

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › tax working in investment apprisal

  • This topic has 1 reply, 2 voices, and was last updated 9 years ago by John Moffat.
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    Posts
  • December 31, 2015 at 11:43 am #293089
    omanim36
    Participant
    • Topics: 1
    • Replies: 3
    • ☆

    Dear Sir,
    i found some questions in investment appraisal not included separate working for tax, whereas some other questions. what is the criteria to have separate working for tax?

    see below example.

    A major retail company which sells its ‘own brand’ products is deciding whether to open new retail outlets in a rapidly expanding overseas market. Past experience from entering other overseas markets has shown that acceptance of the brand can depend on a number of factors and that sales in the first four years are a good indicator of the potential of the market for the future.
    Year 1 sales will depend on how readily the brand is accepted. A consultancy firm, with experience of the overseas market, was employed at a cost of $0.5m to provide detailed information on the market and an estimate of the likelihood of the brand being accepted. The consultancy firm estimated that there is a 50% chance that the brand will be well received and sales in year 1 will be $450m, there is a 20% chance that the brand will be very well received and sales in year 1 will be $600m, and there is a 30% chance that the brand will not be well received and sales in year 1 will be $300m. Sales are then expected to increase by $100m each year, irrespective of sales in the first year.
    An investment of $600m is required to develop and fit out the retail outlets. The costs will be depreciated on a straight line basis over the four year period. The development and fit out costs will be eligible for tax depreciation. It is expected that the retail outlets will have a residual value of $400m at the end of four years. The residual value will be treated for tax purposes as a balancing adjustment. There will also be a requirement for $60m of working capital.
    The average contribution to sales ratio is expected to be 60%. Fixed costs relating to the retail outlets, including depreciation, are expected to be $150m per annum and will remain the same for the four year period. It is also anticipated that a further $50m will be spent in each of the four years on marketing the brand.
    The company’s financial director has provided the following taxation information:
    • Tax depreciation: 25% reducing balance per annum.
    • Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the balance is paid in the following year.
    • Any taxable losses resulting from this investment can be set against profits made by the company’s other business activities.
    The company uses a post-tax cost of capital of 8% per annum to evaluate projects of this type. Ignore inflation.

    Advise the directors of the company whether they should go ahead with the investment from a financial perspective.
    how to work it out without seperate working for taxation and just use captial and operatign cash flow working.
    Ahmed

    December 31, 2015 at 2:29 pm #293099
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    I am sorry, but we cannot answer full questions like this – you must have a printed answer in the same book as you found the question anyway 🙂

    You must always show the workings for the capital allowances (tax allowable depreciation) in the exam.

    To deal with it in the cash flows, you can either calculated the tax on the operating cash flows and then separately show the tax saving on the capital allowances.
    Alternatively, you can subtract the allowances from the operating cash flows, then calculate the tax, and then add back the allowances because they themselves are not a cash flow.

    Either way gives the same answer, but the first way is the easiest and safest.

    This is all explained in our free lecture on investment appraisal with tax. Our lectures are a complete course for Paper F9 and cover everything needed to be able to pass the exam well.

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