FI 1 Capital Budgeting Flashcards
Are relevant cash flows considered before or after tax?
After
Opportunity cost for asset, not in use and in-use
Not in use = sales price less taxes
In use = value-in-use (after tax)
Two methods of calculating CCA tax savings benefits
- CCA deduction taken as part of operating cash flows
2. PV of tax shield on CCA
How is CCA deduction from operating cash flows calculated
CCA claim deducted from op. cash flows. Tax calculated, then CCA added back. Benefit is in lower tax expense.
PV of tax shield formula (no AII). Can this be taken on all CCA classes?
Investment x CCA rate x Corp tax rate / CCA rate + Discouint rate x 1+ 0.5 x Discount rate / 1 + Discount rate
No, only declining balances
PV of tax shield formula (AII).
Investment x CCA rate x Corp tax rate / CCA rate + Discouint rate x 1+ 1.5 x Discount rate / 1 + Discount rate
Temp 100% deduction for CCPC AND 100% for manufacturing/processing/clean energy equipment
classes other than 1-6, 14.1, 17, 47,49 and 51
Investment x Corp tax rate / 1 + Discount rate
What does an increase in W.C. indicate?
cash outflow
Three income tax impacts on disposition of assets
loss of any future CCA tax shield
tax payable on recaptured CCA
tax payable on capital gains
PV of lost tax shield on salvage - assumptions needed?
salvage proceeds x CCA rate x corp tax rate / CCA rate + discount rate.
salvage proceeds must be less than original cost and there are amounts still remaining in CCA pool
Should you adjust for inflation
Yes, if rates given to you
Which discount rate should be used when inflation is given? not given?
nominal if given, real if not
Fisher effect formula for determining real rate of return
(1 + nominal ROR) = (1 + Real ROR) x (1 + inflation rate)
Payback period +/-
It is very simple to calculate, and its results are intuitive and easy to understand.
- It can be a measure of risk inherent in a project assuming the longer payback period is an indication of higher uncertainty and risk.
- It can be used to rank projects for companies focused on pursuing projects that have the quickest cash returns.
- It highlights liquidity.
Limitations of the payback period method include the following:
- It does not take into account the time value of money, which can lead to wrong decisions. However, this limitation can be overcome by using the discounted payback period approach.
- It does not take into account the cash flows that occur after the payback period. For example, one investment may have a shorter payback period than another, but the latter may achieve greater cumulative cash flow over time and have a greater NPV.
- It does not give any indication of value that will be added to the company if the project is accepted.
- It assumes an arbitrary cut-off period for project acceptance.
Payback period formula for uneven cash flows
A +b/c
where A = last period with negative cash flow
b = absolute value of cumulative cash flow at end of period A
c = total cash flow during period right after period A
