ACCA AFM students will be familiar with Tax Allowable Depreciation (TAD). It is regularly tested across several syllabus areas.
TAD is not a cash flow. It is used to ascertain taxable profit which allows us to find a cash flow – the tax payable (or saved).
This piece is not about how you compute TAD as there are a variety of ways this can be done. No, this is about should we or should we not add it back.
With investment appraisal questions, yes, you add TAD back after the tax has been computed. This allows you to ascertain the projects FCF’s. You then discount FCF using WACC, RAWACC or Kei (leading to APV).
However with business valuation and dividend capacity it’s not so straightforward. Both these require the computation of FCF’s. The former can use FCFCO or FCFE, but the latter is only FCFE.
Once the tax has been computed, the issue is now should the TAD be added back. Well, the answer yes or no ?
If the question states that the TAD is equivalent to the amount of investment needed to maintain the asset base, the answer is no. The “+” & “-“ are the same value.
However if it does not state the above and the two amounts are different, then the answer is yes. Add back TAD.
It’s all in the reading of the question – very carefully.