Lecture notes
Project appraisal - tax and depreciation
- Module
- Corporate Finance
- Institution
- The University Of Kent (UKC)
An introduction to market imperfections in project appraisals
[Show more]
Connected book
Book Title:
Author(s):
- Edition:
- ISBN:
- Edition:
Seller
Follow
Content preview
Week 1CB765: Corporate Finance
LECTURE 2
Another market imperfection: taxes
Impact of depreciation, interest expense and capital expenditure on taxes
Estimating free cash flow while considering sunk costs, opportunity costs and changes in
working capital in
investment appraisal
TAXATION AND INVESTMENT APPRAISAL
Taxes (cash outflows) are payable on the profits generated by the firm
Taxes are considered on marginal profit from the project
General template of the profit and loss account
*Taxes are calculated on profit however
in order to calculate profit, non-cash
expenses (i.e. depreciation) must be
considered
DEPRECIATION, INTEREST EXPENSE AND CAPITAL EXPENDITURE
Interest expense: paid on borrowed amount and is typically not included as a cash outflow
The reason for this is that the project should be judged on its own, disregarding how it will
be financed (debt/equity/combination)
Moreover, the discount rate/opportunity cost of capital used in NPV calculations to discount
cashflows, takes care of this aspect
TAX LIABILITY ON PRE-TAX PROFIT
Tax payable on pre-tax profit is calculated as:
Pre-tax profit (EBIT) x marginal tax rate (T c ) = annual tax liability
Where:
EBIT = sales - variable costs – depreciation (or other operating expenses)
So,
Annual tax to be paid = (sales – V.C. – depreciation) x T c
PRACTICAL CONSIDERATIONS IN PROJECT APPRAISAL: FREE CASHFLOW
Sunk cost: a cost incurred in the past that cannot be recovered regardless of the investment
decision (irrelevant)
Opportunity cost: the cost of the next best alternative forgone (relevant)
Changes in the network capital due to undertaking a new project
Estimation of Free Cashflows (FCF) to find NPV
FCF = (revenues – costs – depreciation) x (1 – T c ) *Subtracting depreciation helps to reduce a firm’s tax
+ depreciation – CapEx - ∆NWC liability but is added on after calculating the NOPAT as it is
a non-cash item (not relevant in investment decision)
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller evelinateye. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £5.99. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
66579 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy revision notes and other study material for 14 years now