Capital Allowances Question

Finance Grad 2015

Hi All,

I need help with this Capital Allowances question... I've read all the books etc but I just can't seem to get my head around it.
Can anybody tell me the layout of the answer... this is where I'm getting stuck... I don't know how to actually calculate it. Depreciation always gets me confused.

Thanks!

Cresswell plc is considering investing in a new product.

• An initial investment of €800,000 would be required comprising plant and machinery of €500,000 and working capital of €300,000. The investment would last for 4 years.

• Additional sales revenue would be generated at €400,000 per year and additional production costs would be €180,000 per year.

• Additional fixed costs of €20,000 per year would be incurred and in addition the company would allocate fixed costs to the project of €15,000 per year.

• At the end of the project's life (year four) the machinery would be sold for €80,000 and the working capital could be recovered in full in year five..

• The Company uses straight line depreciation.

• For a project of this nature the company use a 10% discount rate.

You are required to


iii. Explain the effects tax has on project appraisal. You are told that Cresswell pays tax at 30% and that capital allowances are available at 12.5% on a straight line basis on the machinery. Recalculate the NPV on this basis

Alan Shore

Assuming you have done the computation without the inclusion of the tax benefits of Capital Allowances.

So you have 500,000 x 12.5% = 62,500 in cap alls so a tax reduction of 7,812.50 each year.

In year 4 you will have a balancing allowance which will reduce your tax bill that year.