Calculation of Cash Inflows in Replacement Decisions
(a) At first Cash flow before Depreciation and tax will be calculated for existing situation.
(b) After that Cash Flow before Depreciation and tax will be calculated for new situation.
(c) After that Incremental Cash Flow before depreciation and tax will be calculated (b - a). Tax will be calculated on incremental cash flow before depreciation and tax & deducted.
(d) After that Incremental depreciation will be calculated. Incremental depreciation is difference of depreciation between new situation & old situation.
· In India depreciation is allowed as deduction every year in respect of fixed assets as per the rates prescribed in the Income Tax rules. The depreciation method allowed for computing taxes is the WDV method. Depreciation is computed on the W.DV of the block of assets.
· In the absence of information it may be assumed that both the assets i.e. old and new belongs to same block.
· If there is any subsequent capital expenditure incurred or any subsidies received in relation to that asset these will be added or deducted, as the case may be at the time of calculation of. W.D.V of relevant year.
· In the absence of any information block of assets method shall be used for calculation of depreciation.
(e) Tax shield on Incremental depreciation will be calculated and added to Incremental Cash flow before depreciation after tax. Sum of both will be treated as cash inflow for decision-making.
Alternatively First incremental depreciation may be deducted from incremental cash flow before depreciation and tax. It will give incremental Profit before tax. After deducting tax from it we will have incremental Profit after tax. Incremental depreciation will be added back to it. If will give Incremental cash inflow for decision-making. It will be same as amount obtained in step (e) as above.
(f) In the last year of the useful life of the assets. following amounts will be added in the figure calculated as above (in 5th step).
(i) Incremental Salvage Value
(ii) Recovery of additional working capital introduced in the beginning. In the absence of any specific information, it shall be assumed that additional working capital introduced in the beginning will be recovered fully at the end of the project.
(iii) Tax shield or tax liability on incremental capital loss or capital gain respectively will be adjusted as per provisions of section 50 of Income tax Act. As a practicable measure it-may be assumed that block of asset to which this particular asset pertains cease to exist after the useful life of the project.
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