Exchange rate 6 Flashcards
The investment and depreciation schedule is prepared This table includes all investment data. The prices should be expressed in nominal terms. This table serves two purposes.
The first is to determine the depreciation expense that will be included in the income tax statement that is used to determine the income tax liability.
The second purpose is to develop residual values for the project’s assets. These are typically based on economic rates of depreciation for depreciable assets.
The economic rate of depreciation will be applied to the value of the asset in the year it
was acquired
The financing schedule typically includes all the loans by date of disbursement. Repayments of financing cost are estimated using
nominal interest rates
The loan and repayment flows are then converted into
domestic currency using the
nominal exchange rates.
If the project is to pay taxes,
First, an income statement construct
second cash flow statement construct
income tax statement include
- costs of goods sold,
- depreciation and amortization expenses,
- overheads,
- interest expense
cash inflows or reciepts
sales,
accounts receivable
residual values of the project’s assets
All receipts
inclusive of VAT and other sales taxes are added up for each year to determine annual cash inflows
All expenditures are
added up for each year to determine annual cash outflows.
Nominal expenditures are broken down into X and included in the cash flow statement. If the project is
using any existing assets the Y of these assets should be included with the investment expenditures.
investment expenditures and operating expenditures
opportunity cost
VAT paid on purchases
can be claimed as input tax credit
the amount of VAT collected in excess of input tax credit should be
deducted as a cash outflow from the project
from the owner’s point of view is constructed
by adding the X as inflows and Y as outflows to the cash flow statement estimated from the viewpoint of total invested capital
debt
interest and principal repayment
The increased investment expense has three effects
First, it increases the interest costs of the project.
Second, it increases the nominal amount of loan principal (50% of nominal investment costs) which must be repaid by the project.
Finally, it results in a larger nominal depreciable expense that will be deductible from future taxes
investment financing normally take place
in year 0 and sometimes in year 1 also
A commercial enterprise will need to maintain an amount of cash on hand that is related to the
value of sales and purchases they carry out.
an “inflation tax” on cash holdings
The resulting loss in the purchasing power of cash balances is referred to
project evaluators should incorporate a number of inflation projections in order to determine the
sensitivity of total costs to the impact of inflation on the cost of holding the desired level of real cash balances.
In the inflation condition, the PV fall because
inflation causes the real value of outstanding trade credit to fall
In the inflation condition, account receivables
and account payables condition
1 try to reduce length: othereise increase of selling price.
2 try to more delay or increase length: real value of the obligation is falling during the period of time prior to the payment.
nominal value of purchase in time of inflation
increase
ACC payable nominal expenditures
purchase + change in account payable
ACC real expenditure
nominal expenditure / PI
inflation reduces the future value of both the
loan repayments and real interest rate payments
real cash flow
without inflation
loan
loan principal + interest + repayment
the higher nominal interest rate increases the but decreases the
cash outflows,
value of the principal that is due at the end of the project
effect of inflation on tax
the higher interest payments shown in the previous section ( in condition without inflation) increase the amount of tax deduction.
Second, inflation reduces the value of the depreciation allowances taken for earlier investments in the project and tax saving fall.
Finally, the method used to account for inventory has an effect on the nominal earnings that are used to determine the taxable income
interest payments are deductible from income for the calculation of taxes, while principal repayments are
not deductible
The higher nominal interest payments are
deductible from taxable income, hence they serve to reduce the amount of taxes
The higher nominal interest rate and higher inflation forces the project to
repay its loans faster than if the inflation rate and nominal interest rates were lower but PV remain same
Real Tax Savings without inflation
dep for each period * tax rate
a first-in-first-out basis (FIFO)
price of the oldest inventories (first in) is the value which is used to determine the cost of the goods sold (COGS).
This means that the difference between the X
and Y the is the taxable revenue from the project.
COGS
sale price
sale prices are affected immediately by the rate of inflation, while the X from inventories are valued using prices of a previous period when the nominal prices were presumably lower.
costs of goods sold
Comparing the effects of inflation on the tax liability in the FIFO and LIFO accounting systems, we see that in both cases, inflation
increased the taxes
Using FIFO, inflation increased the taxes in X period, whereas using LIFO results in no increase in taxes in the Y but in a larger tax liability in the z
each
production period
last sales period
Using LIFO could increase the X associated
with the project in a high inflation environment if the reason for the enterprise wanting to Y was financial stress or business slow down
overall risk
lower the level of inventories
