Chapter 5 • Practical aspects of investment appraisal
part) and the £10,000 rent of the outside warehouse will be paid: thus they are irrelevant
to the decision.
3 Overheads.The retiring manager’s salary makes a difference of £20,000 p.a. depending
on the decision. Irrespective of the decision the manager will be paid £10,000 p.a., so it
is the £20,000 that is relevant. The other £60,000 is also relevant. The apportionment of
overheads is not relevant as this is not the amount of the difference in overheads associ-
ated with rejection or acceptance of the project.
4 Interest.This will be taken into account by discounting.
5 Contributions from lost Whizzo sales.These amount to £400,000 [that is, 10,000 ×£(80 −
40)] for years 1 and 2, and £200,000 [that is, 5,000 ×£(80 −40)] for years 3, 4 and 5.
Since lost Whizzo sales do not affect overheads, only sales revenue lost (£80 per unit)
and variable costs saved (£40 per unit) are relevant to the decision.
This aspect must be accounted for, as accepting the project will affect Whizzo sales.
Corporation tax cash flows
The relevant operating cash flows will also be the basis of the differential tax charges. Capital
allowances on the initial investment will be as follows:
Allowance Tax savings
Year Balance claimed (at 30%)
£000 £000 £000
1 Acquisition 1,200
Capital allowance (CA) (25%) (300) 300 90
900
2 CA (25%) (225) 225 68
675
3 CA (25%) (169) 169 51
506
4 CA (25%) (127) 127 38
379
5 CA (balancing allowance)
(nil proceeds) 379 379 114
The tax payable will be as follows:
Operating cash
flow surplus Tax payable
Year (adjusted for inflation) (at 30%)
£000 £000
1 294 (280 ×1.05) 88
2 309 (280 ×1.05^2 )93
3 556 (480 ×1.05^3 ) 167
4 583 (480 ×1.05^4 )^175
5 613 (480 ×1.05^5 ) 184
Notes
1 Each of these payments will be treated as occurring at the end of the year concerned.
2 The tax-payable amounts represent the difference between the tax that would be payable
if the project were accepted and that which would be payable if it were rejected. It is not
necessary for us to know what the tax payable would be in total; we need only know the
difference.