Student Forums CMA Part 2 Section E: Investment Decisions Question ID: Ultra-Comp (Topic: Real Options in Capital Budgeting – Ultra Comp)

Question ID: Ultra-Comp (Topic: Real Options in Capital Budgeting – Ultra Comp)

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  • #244317

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    This forum is restricted to members of the associated course(s).

    george demian
    Participant

    Hello

    i -am so confused . in all question od NPV we add the dep tax shield to operating income to calculate cashflow

    in this question he adds all the depreciation amount not only dep tax shield

    please help me !!!!!!!!!!!!!!

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  • #244364

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    Lynn Roden
    HOCK international

    Hello george demian,

    I do not see any mention of depreciation in the Ultra Comp essay question. We can only work with the information given. So we must assume that the depreciation tax shield is included as a decrease in the annual cash outflow and the annual cash outflow given in the question for each vendor’s product is a net annual cash outflow.

    This question and its answer were released by the ICMA. The ICMA will sometimes do the interim calculations in a question because they know it would take candidates too much time to do them. That is probably what they did with this question. So in answering it, just use the “annual cash outflow” as it is given, as the net cash outflow that has already been reduced by the depreciation tax shield.

    Lynn

    #244375

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    george demian
    Participant

    i-m sorry i mentioned wrong title

    what i mean is Question ID: Right-Way (Topic: Real Options in Capital Budgeting – Right-Way Stores)

    in the answer he adds all Dep Expense 175000

    what i know is we should add only 17500*0.35 to calculate tax shield 

     

     

    #244378

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    Lynn Roden
    HOCK international

    Hello george demian,

    After-tax operating income is different from after-tax operating cash flow. Operating income includes a deduction for the depreciation expense, whereas operating cash flow does not.

    The third way of calculating after-tax operating cash flow given in the answer is more like the way you are accustomed to calculating after-tax operating cash flow and the adjustment for the depreciation tax shield. The steps are:

    1. After-tax operating income, given in the question, including a deduction for depreciation expense, is $1,200,000.
    2. Before-tax operating income, including a deduction for depreciation expense, is $1,200,000 / (1 – 0.35) = $1,846,154.
    3. Before-tax operating cash flow, not including any depreciation, is $1,846,154 + $175,000 = $2,021,154.
    4. After-tax operating cash flow, not including any depreciation, is $2,021,154 × (1 – 0.35) = $1,313,750.
    5. The depreciation tax shield is $175,000 × 0.35 = $61,250.
    6. The after-tax cash flow, including the depreciation tax shield, is $1,313,750 + $61,250 = $1,375,000.

    The other methods of calculating it get you to the same answer. They just go about it a little differently.

    Lynn

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