- 5 Marks
FM – L2 – Q56 – Discounted Cash Flow
Question
Zest Ltd is considering whether or not to invest in a four-year investment project. The project will require the purchase of equipment costing GH¢800,000. This will have an estimated residual value of GH¢200,000 at the end of Year 4. The equipment will be depreciated by the straight-line method.
The profits before interest and tax from the project are expected to be GH¢400,000 each year. Tax is payable at 30% one year in arrears.
The equipment will qualify for capital allowances (tax depreciation allowances) of 25% each year, using the reducing balance method. The first claim for an allowance would be made against Year 0 profits.
The after-tax cost of capital is 15%.
Required:
Calculate the NPV of the project.
Answer
Annual depreciation = GH¢(800,000 – 200,000) / 4 years = GH¢150,000 Per Annual cash profits = Accounting profit + Depreciation = GH¢250,000 + GH¢150,000 = GH¢400,000.
Tax depreciation allowances (capital allowances)
| Year of claim | Written down value | Tax saved at 30% | Year of cash flow | |
|---|---|---|---|---|
| GH¢ | GH¢ | |||
| 800,000 | ||||
| 0 | Allowance (25%) | (200,000) | 60,000 | 1 |
| 600,000 | ||||
| (150,000) | 45,000 | |||
| 450,000 | ||||
| (112,500) | 33,750 | |||
| 337,500 | ||||
| (84,375) | 25,313 | |||
| 253,125 | ||||
| (200,000) | ||||
| 53,125 | 15,938 |
- Tags: capital allowances, Discounted cash flow, investment appraisal, NPV, Taxation
- Level: Level 2
- Topic: Discounted cash flow
- Uploader: Samuel Duah