Calculation of Cash out Flow under Replacement Decisions
Cost of New asset *
Add: Installation cost and other direct cost relating to asset *
Add: Additional working capital requirement *
Less: Lesser working capital requirement (*)
Less: Sale proceeds of existing machine (*)
Less: Tax shield on Capital loss on sale of existing machine (*)
Add: Tax payable on capital gain on sale of fixed assets *
Add: P.V. of subsequent capital expenditure, if any *
Less: Present value of subsidy received, if any (*)
Net cash outflow *
(a) In India, as per provision of Income Tax Act, block of assets method is used for calculation of depreciation and short-term capital gain/loss on disposal of assets. When block of assets method is adopted, tax shield or tax payable on capital loss/gain on disposal of existing asset is recognized as per provision of section 50 of Income tax Act. According to section 50 of Income Tax act, Short term capital gain or loss arises in this situation only subject to following conditions:
· Short term capital loss arises if only if, all the assets of a particular block are sold out, and sales consideration is less than the opening WDV of that block + any addition in that block during the year, which is not possible in this situation as in capital budgeting decision we replaces existing machine with another machine hence block does not cease to exist.
However, if new asset pertains to different block, short-term capital loss may arise on sale of existing machine subject to one condition that no other assets remain in that block after replacement.
· Short term capital gain is also not possible in this situation, as this arises if only if, sale proceed of existing machine is more than the opening written down value of that block + any addition during the year, which is normally not possible in capital budgeting decision as in such cases cash outflow will be negative.
However if both old and new assets pertain to different blocks. short term capital gain on disposal of existing asset may arise subject to one condition that sale proceed of existing asset is more than the opening WDV of that block. + Any addition during the year in that block.
(b) While calculating Cash outflow sunk costs if any shall be excluded. Sunk cost" is the cost that has already incurred and thus has no effect on the present or future decisions. The sunk costs are neither recovered if the proposal is rejected nor incremental if the project is accepted and therefore should not be considered in the capital budgeting decisions process. For example expenses incurred on conducting a market survey to assess the potential market.
(c) Opportunity costs are relevant costs and considered as a portion of cash flows in the capital budgeting process. The general framework for analyzing the opportunity costs begins by asking the question "Is there any other use for this resource right now?
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