Originally published:1986-10 as Discussion paper (Lincoln College (University of Canterbury). Agricultural and Economics Research Unit) ; no. 103 by Lincoln College. Agricultural and Economics Research Unit.
Investment appraisal techniques such as the net present value and the
internal rate of return methods are frequently used to assess the
worthwhileness of a capital investment. A number of factors will influence the outcome of an investment
appraisal exercise including inflation, finance and taxation. While there
can be no excuse for ignoring the effects of inflation in an investment
appraisal the other two factors are frequently ignored. The rationale for
this is that financing requirements and tax liability differ from business
to business even though the projects under consideration are identical.
Variations in the financing and tax situation will lead to variations in
the results of the appraisal which have nothing to do with the intrinsic
merit of the project. Excluding finance and tax enables an appraisal to
be made of a project in general terms. This is termed general financial
analysis.
Once a general financial analysis has been carried out and the project
has been shown to be worthwhile in general terms, then the appraisal can
be reworked incorporating the individual developer's specific finance
requirement and tax situation. This is known as specific financial
management.
Although cumbersome it is argued that this two stage approach is
logical because the general financial analysis, which is relatively
straightforward, can be used as a screening procedure before carrying out
the more complex financial analysis only on these projects which have
passed the initial screening. Great care must be exercised in deciding
which projects to reject at this stage since the effects of differing
marginal tax rates and depreciation allowances can render some apparently
marginal projects worthwhile (e.g. Burrell et al). The second stage of the assessment is often incorrectly omitted
because of the complexities associated with the inclusion of tax payments
and reliefs in the appraisal procedure. It is the purpose of this report
to consider the different ways of dealing with taxation in investment
appraisal and to present a set of tables that can be used to ease the
calculation procedures. The interrelationship between tax, inflation and
finance in investment appraisal will also be considered.[Show full abstract]
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