Calculate Money Price Level

Calculate Money Price Level

Money price level can be calculated from today price level (real price level).

 Money price level Example

Sales recorded for year 2001 at today price level in 3 years would be 600,000. What would be money price level, if inflation is 12%.

Solution

Today price level = 600,000

Inflated price level = 600,000 (1+.12)³

842,957 (money price level)

Today Price Level

Today Price Level

Today price level means there is no inflation accounted for or allowed (prices without inflation). Today price level is also known as real price level.

Today price level Example

Revenue at today price level in 5 years would be 400,000. What would be inflated price level, if inflation is 9%.

Solution

Today price level = 400,000

Inflated price level = 400,000 (1+.09)⁵

615,450 (Inflated price level)

Tax and cash Flows

Tax and cash Flows

Tax on profit or income will reduce your cash flows, because you need to pay tax which is an outflow of cash, while tax on expense will reduce improve your cash flow due to tax saved on expenses.

Expenses = save tax = tax payment reduces= cash outflow reduces

Income = Tax imposed= Tax payment = cash outflow increases

Tax and cash flows Example

ABC Co cash profit for the year ended 2001 is 70,000. Tax rate applicable on company is 30%, depreciation expense during the year 2001 was 20,000. Calculate the net cash flow.

Solution

Cash profit = 70,000

Less tax Expenses i.e. 30% of 70,000 (Cash profit) = (21,000)

Add tax saving i.e. 30% of 20,000 (Depreciation) = 6,000

Net Cash Flow = 55,000

It is important to remember that income increase tax expense, while expense reduces tax expense.

Tax and cash profit

Tax and cash profit

Tax payable on profit is deducted from the cash profit, because tax will be paid and this will reduce cash inflows, similarly tax saved on depreciation would be added to cash profit, because such this is tax saving.

Tax and cash profit Example

ABC Co cash profit is 50,000. Tax rate is 30%, while depreciation charged during the year was 10,000. Calculate the net cash flow.

Solution

Cash profit = 50,000

Less tax Expenses i.e. 30% of 50,000 (Cash profit) = (15,000)

Add tax saving i.e. 30% of 10,000 (Depreciation) = 3,000

Net Cash Flow = 38,000

It is important to remember that income increase tax expense, while expense reduces tax expense.

Balancing Depreciation

 Balancing Depreciation

Balancing depreciation concept is widely used at the end of project. When the project is ended then assets is to be fully depreciated. This concept has been explained below with example.

Balancing Depreciation Example

ABC & Co purchased Machinery for a project costing 100,000. The project life was three year and asset to be depreciated @ 30% reducing balance method. At the end of year 3, the residual value of machinery was 50,000. Calculate the depreciation for all three years.

Solution

Year 1 Depreciation = 100,000 x 30% = 30,000

Year 2 Depreciation = (100,000-30,000) x 30% = 21,000

Year 3 WDV = 100,000- 30,000-21,000 = 49,000

Year 3 Depreciation = 50,000 (Residual Value) - 49,000 (WDV at beginning) = 1000 (Depreciation)

As the project has ended so therefore the asset is to be fully depreciated in year 3, and this can be done by following formula, it is to be noted that depreciation rate is no more relevant is year 4 (at end of project).

Example of Balancing Depreciation

Example of Balancing Depreciation

Machinery written down value at the beginning of year was 30,000 and residual value at the end of year 4 is 40,000. Project life was four year?

Solution

As the project has ended so therefore the asset is to be fully depreciated in year 4, and this can be done by following formula, it is to be noted that depreciation rate is no more relevant is year 4 (at end of project).

Depreciation = Residual value end of year 4 – WDV at beginning of year 4

= 40,000-30,000

= 10,000 (balancing depreciation for year 4 or at end of project)

Future Annuity Example

Future Annuity Example

Present value of Future annuity may be calculated by the following formula

C x (Annuity Factor) x Discount Factor

Future Annuity Example

Mr. Sheraz Khan contacted an insurance company for annuity. He was offered an annuity amount of $ 25,000 for 3 years. Discount rate for annuity is 8%.  Calculate the present value of the annuity, where annuity start in 4 years

Solution

In first place annuity present value is calculated at year 4, and then it is further discounted at zero year. it means the future annuity calculation, we need to perform discounting twice.

1.    Calculate the annuity at year 4

= 1-(1.08)^-3

        .08

=2.577

= $ 25,000 x 2.577

=64,427

2.    Discount the present value at year zero

$ 64,427 x (1+.08)^-4

=$64,427 x .7350

=47,353

Tip of future annuity

Two present value are calculated

1.    Present value is calculated at future year by annuity factor (Single Value)

2.    Present value is calculated by discounting the value calculates by annuity factor.