Observation. Question 1 of AFM, March/June 2017. The Sample Answers treatment of Depreciation and Interest is confusing to me. To estimate the value of the Manufacturing Business Unit that the management of a Chryso Co had decided to unbundle,
Depreciation value of the assets is deducted in the calculation of the cash flow and not added back. Is the convention and practice not for depreciation to be deducted only for the purpose of calculating tax and to be added back after calculating the Tax payable.?
The same method is used in estimating the value of the company Chryso Co. Depreciation is deducted to calculate the cash flow as if depreciation is regarded as a cash flow.
While Chryso Co has a 4.5% unsecured bond and should enjoy a tax shield accordingly, the Sample Answer neglects this altogether. There is no deduction of interest in the calculation of tax payable.
Please, who has observed similarly? I need clarity to be sure I’m not the one getting things confused.
Thanks
Watch this video in YouTube. U will get clear hopefully.
https://youtu.be/9QFzl9Yn0pg
there is a sentence in additional financial information saying that annual reinvestment is equal to depreciation. first you need to add back depreciation to after tax cash flows and reinvest portion need to be deducted which is equal amount of depreciation. In total nil effect on cash flows.
with that line they ignored it, without any adjustments being made.
