Question

I have been asked to create cash flows for an expansion of a company. I have received the income statement for the year prior to the decision for the commencement of the expansion. Do I need to do anything with the tax expense that was on that income statement. I’m a little confused as the expense was incurred prior to the expansion but wouldn’t it have to be paid in the following year (which would be year one the cashflow for the expansion) ?

Answer 1

Assuming that you mean that expansion expenditure in the period to cash flow from the expansion:

Then tax would have been taken into account into the cash flow in case:

The capital installed was depreciated in the previous year. This depreciation would have reduced the EBT, consequently reducing the tax liability and increasing the cash flow, thereby reducing the overall and effective Capex cash outflow from the project.

Example:

Capex = 100

Depriciation = 20%

Assuming Tax Rate = 40%

Effective reduction of tax in period 0 = 20 * 40% = 8

Cashflow from expansion project in period 0= -100 + 8 = -92