EFN406 Lecture 06 2009

# EFN406 Lecture 06 2009 - EFN406 Managerial Finance Topic 6...

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2009 EFN406 Managerial Finance EFN406 Managerial Finance Topic 6 Capital Budgeting - Taxation

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2009 EFN406 Managerial Finance Outline Taxation and Depreciation After tax cash flows Depreciation Timing Inflation Non Identical Replacement – Perpetual Chain Methods to handle risk and uncertainty Scenario Analysis Sensitivity Analysis (6.5.1) Simulation (6.5.3) Decision Tree analysis (6.6) Certainty Equivalents (14.9) Adjusting for Systematic Risk (next week)
2009 EFN406 Managerial Finance Required Reading Peirson, Brown, Easton, Howard and Pinder, Business Finance, 10th edition, McGraw-Hill, 2009 Chapter 14, Read and study all of section 14.8 (pages 447 to 452)

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2009 EFN406 Managerial Finance Learning Objectives Understand the effect of taxation on project cash flows Calculate NPV using after tax cash flows Conduct sensitivity analysis
2009 EFN406 Managerial Finance Taxation Taxation is a cash flow NPV needs net cash flows Three steps in investment analysis calculate tax cash flows calculate net cash flows find the present value Need to consider depreciation timing of tax payments and receipts special tax provisions

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2009 EFN406 Managerial Finance Depreciation Depreciation is calculated according to tax legislation not accounting standards Many variations in Tax Act, but 2 main types straight line [SL] (prime cost) diminishing value [DV] reducing value Note salvage value is ignored when calculating depreciation for tax purposes
2009 EFN406 Managerial Finance Straight Line or Prime Cost For NPV (do not use accounting formula) Straight line in dollars = cost/life Cost \$100000 and 5 year life: Dep = 20000 In percentage 1/life = 1/5 = 20% The salvage value is accounted for at the end of the life of the asset

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2009 EFN406 Managerial Finance Acquisition Cost 100000 Straight Line Diminishing Value Life 5 Prime Cost Reducing Value S/L 20% D/V 40% O/B 100000 100000 Depreciation Year 1 20000 40000 BV 1 80000 60000
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