Inflation, taxation and working capital

In this lesson

1. 0:00 Section four: inflation, taxation and working capital
2. 0:05 Tax basics and cash flow relevance
3. 1:30 Tax allowable depreciation explained
4. 2:31 Calculating tax allowable depreciation step by step
5. 4:11 Tax effect on profits and NPV
6. 5:08 Understanding inflation in investment appraisal
7. 6:58 Fisher formula: real and nominal rates
8. 8:01 Applying Fisher formula to cost of capital
9. 9:45 Working capital changes in NPV calculations
10. 11:14 Working capital calculation with inflation example

About this lesson

Understanding how to incorporate these correctly will significantly improve your NPV calculations and exam performance. The session covers taxation first, explaining how tax allowable depreciation (capital allowances) reduces taxable profit and therefore the tax you pay. You'll work through the mechanics of calculating tax allowable depreciation on a reducing balance basis and learn the AFM approach: deduct the allowance from taxable profit, calculate tax on the reduced figure, then add the allowance back. The key principle is that only the tax impact—not the depreciation itself—represents a cash flow in your appraisal. On inflation, you'll discover the critical distinction between real cash flows (at current prices, using a real discount rate) and nominal cash flows (future prices including inflation, using a nominal discount rate). The Fisher formula links these together and is essential for getting your discount rate right. You'll practise applying it to real exam scenarios so you can confidently convert between real and nominal rates. Finally, you'll master working capital adjustments by understanding that increases in working capital represent cash outflows and decreases represent inflows. The session shows you how to calculate incremental working capital changes as a percentage of sales and how to handle the reversal of working capital at the end of a project. By the end, you'll have the practical skills to handle all three elements accurately in your investment appraisal calculations.

Duration: 13m