NPV Residual value - add back or not?

reddwarf

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

SandyHood

Treat the cash flow from selling the asset as an inflow in the year it is sold

reddwarf

Thanks Sandy.

SandyHood

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.

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