By Graham Mott
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Another example of this opportunity cost frequently occurs when a new project can utilize existing machinery which would otherwise be sold. Here again the sale price of the machinery is taken as a relevant cash flow on this project because a similar amount of cash would have to be spent on another machine if this one had not been available. It is important to realize that it is the present worth of an existing asset which should be counted as the cash flow. The original cost or written down value of the asset is irrelevant in a DCF appraisal.
These PV factors are based on a whole year's interest charge on the assumption that the cash transaction takes place on the last day of the year as opposed to a continuous flow throughout the year. In the case of discrete receipts and payments of cash, for example on the purchase of an asset or the receipt of a grant, this approach would be valid. In the case of receipts from everyday sales or payments for labour, materials and other expenses this approach is less valid because of the continuous nature of such cash transactions throughout the year.
The following illustration shows how in Year 2 the effective tax rate can rise above 52% when the depreciation that is disallowed is not offset by an equal amount of capital allowances. 4% Add back: depreciation Deduct: 100% capital allowance on In Year 2 when no new investment in equipment takes place, a higher depreciation charge is added back because of the previous year's new purchase. No allowances are 53 available in this later year if no new investment takes place as roo% allowances have already been claimed in previous years on existing equipment.