[jahnesta8]

A project’s net present value, ignoring income tax considerations, is normally affected by the:

a. Carrying amount of the asset to be replaced by the project.

b. Amount of annual depreciation on the asset to be replaced.

c. Amount of annual depreciation on fixed assets used directly on the project.

d. Proceeds from the sale of the asset to be replaced.

Becker’s Response:

Explanation

Choice “d” is correct. A project’s net present value is a function of current and future cash flows, including proceeds from the sale of the old asset.

Choice “a” is incorrect. A project’s net present value is a function of current and future cash flows. The carrying amount of the asset does not affect cash flows.

Choice “b” is incorrect. A project’s net present value is a function of current and future cash flows. Depreciation is a noncash item and does not affect cash flows.

Choice “c” is incorrect. A project’s net present value is a function of current and future cash flows. Depreciation is a noncash item and does not affect cash flows.

I understand that the proceeds from the sale of the asset to be replaced reduces the initial outflow of cash, however I find Becker’s response to be misleading and would appreciate any input from others.

Becker is basically saying that only cash inflows and outflows affect the npv, and that since depreciation does not involved the exchange of cash, it does not affect cash flows. Don’t we treat (depreciation x tax rate) as an indirect cash inflow when calculating the npv of a project or capital acquisition?

[How many letters do you need]

Jahn: we do! They snuck in the “ignoring income tax considerations. Since income tax is ignored, so are income tax deductions. It's a tricky one I had to read twice and I've been doing NPVs for 20 years…

MBA,CMA,CPA, CFF?, ABV?

[How many letters do you need]

Jahn: we do! They snuck in the “ignoring income tax considerations. Since income tax is ignored, so are income tax deductions. It's a tricky one I had to read twice and I've been doing NPVs for 20 years…

MBA,CMA,CPA, CFF?, ABV?

[jahnesta8]

Thanks! I noticed that, but then figured that income taxes would also need to be considered if we are including the sales price of the old asset, as any gain or loss would have tax consequences as well. If this were true, we would also need to know the replaced assets carrying value to determine the gain/loss recognized?

Is this just a bad question with bad answer choices compounded by a bad Becker explanation?

[jahnesta8]

Thanks! I noticed that, but then figured that income taxes would also need to be considered if we are including the sales price of the old asset, as any gain or loss would have tax consequences as well. If this were true, we would also need to know the replaced assets carrying value to determine the gain/loss recognized?

Is this just a bad question with bad answer choices compounded by a bad Becker explanation?

[NYCaccountant]

The answer is correct. From what I remember, you take cash inflows, outflows, working capital increases and terminal value into consideration when determining NPV. Terminal value is the value you eventually sell the asset for and this could be different from the salvage value.

FAR - 93
REG - 87
BEC - 84!!!!
AUD - 99!!!!!! CPA exam complete.

[NYCaccountant]

The answer is correct. From what I remember, you take cash inflows, outflows, working capital increases and terminal value into consideration when determining NPV. Terminal value is the value you eventually sell the asset for and this could be different from the salvage value.

FAR - 93
REG - 87
BEC - 84!!!!
AUD - 99!!!!!! CPA exam complete.

[jahnesta8]

NYCaccountant: You missed potential depreciation tax shields, which is the problem I have with the question. You also take into consideration the proceeds received from the sale of the replaced asset and the gain or loss on that asset.

[jahnesta8]

NYCaccountant: You missed potential depreciation tax shields, which is the problem I have with the question. You also take into consideration the proceeds received from the sale of the replaced asset and the gain or loss on that asset.

[How many letters do you need]

Jahn: remember for NPV we are talking about cash flows. Book value only ever enters the world of NPV when there are tax considerations to think about, to determine the taxable amount of gain/loss at termination. In the real world of corporate finance, most of the time we don't even look at that because generally projects are fully depreciated before salvage, although that's not always the case and certainly something to stick in mind as a potential tricky CPA question. However, when they say the magic phrase of “ignoring tax considerations”, it's just a pure cash flow problem and anything involving depreciation or book value goes out the window.

As a side note, the other thing I've noticed as an addition to the “CPA way” of calculating NPV is the working capital investment. I have to kick myself everytime one of these things come up, because the way I learned it working capital is not usually taken into consideration (it could also be that it's been a while since undergrad and they have adapted this into the calculation for finance too). Either way, I ALWAYS forget to take the PV of the working capital investment at project termination. These little things are important because they can add up to serious points on the exam…

MBA,CMA,CPA, CFF?, ABV?

[How many letters do you need]

Jahn: remember for NPV we are talking about cash flows. Book value only ever enters the world of NPV when there are tax considerations to think about, to determine the taxable amount of gain/loss at termination. In the real world of corporate finance, most of the time we don't even look at that because generally projects are fully depreciated before salvage, although that's not always the case and certainly something to stick in mind as a potential tricky CPA question. However, when they say the magic phrase of “ignoring tax considerations”, it's just a pure cash flow problem and anything involving depreciation or book value goes out the window.

As a side note, the other thing I've noticed as an addition to the “CPA way” of calculating NPV is the working capital investment. I have to kick myself everytime one of these things come up, because the way I learned it working capital is not usually taken into consideration (it could also be that it's been a while since undergrad and they have adapted this into the calculation for finance too). Either way, I ALWAYS forget to take the PV of the working capital investment at project termination. These little things are important because they can add up to serious points on the exam…

MBA,CMA,CPA, CFF?, ABV?

[jahnesta8]

Thank you!

[jahnesta8]

Thank you!

[Author]

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