NPV Residual value - add back or not?

We had this question in a test and our tutor was unsure whether we should add the residual amount into year four.

quote
Initital investment year 0 £120000.

Savings Year 1 £55K,Year 2 £55K, Year3 £60K, Year 4 £60K

The residual value of the project at the end of the four years (year 4) is expected to be £30,000.

The discount rate of 10% is to be used in the appraisal of the investment.

rates: 1.00, .909, .826, .751, .683

unquote

Comments

  • SandyHood
    SandyHood Registered, Moderator Posts: 2,034
    Treat the cash flow from selling the asset as an inflow in the year it is sold
    Sandy
    [email protected]
    www.sandyhood.com
  • reddwarf
    reddwarf Registered Posts: 528
    Thanks Sandy.
  • SandyHood
    SandyHood Registered, Moderator Posts: 2,034
    To the person who emailed me asking about the cash inflow from the sale of the asset
    1. The AAT syllabus for Costs and Revenues does not include tax cash flows.
    2. When looking at tax cash flows they come from 2 sources
      1. Tax on operations which I don't think you are asking about
      2. Tax depreciation

    When an asset is sold there might be a balancing charge or a balancing allowance depending on the value and the amount of tax depreciation (or as we call it in the UK the "capital allowance")

    This investment was £120,000
    If the tax authority allowed a 25% capital allowance on a reducing balance this would mean that the carrying value of £37,969 at the end of year 4. If it is then sold for £30,000 then a balancing allowance of £7,969 can be added. Such allowances reduce the total tax payable by the company.

    If the tax authority allowed a 50% capital allowance in year 1 and 25% on a reducing balance in subsequent years this would mean that the carrying value at the end of year 4 would be £25,313. If it is then sold for £30,000 then a balancing charge would be made by the tax authority for the £4,687. This increases the tax payable by the company.

    Tax and capital investment appraisal is addressed in chapter 11 of Management and Cost Accounting for Dummies. It was part of an earlier AAT syllabus, but is not included in any unit of the current AAT qualification.

    http://eu.wiley.com/WileyCDA/WileyTitle/productCd-1118650492.html
    http://www.amazon.co.uk/Management-Accounting-Dummies-Business-Personal/dp/1118650492
    Sandy
    [email protected]
    www.sandyhood.com
Privacy Policy