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Subject P2: Advanced Management Accounting
11.5
A single cash out flow followed by an annual cash inflow to be received in
perpetuity: Real flows real rate
The cash inflows will each be subject to a differing rate of inflation: Money
flows money rate
The cash inflows will be subject to corporation tax: Money flows money rate
Most of the cash flows are annuities – all are affected by the same single rate of
inflation: Real flows real rate
Individual cash flows are all expressed in current terms: Real flows real rate
If there is one rate of inflation only to be considered, both the real and money
method will give the same answer. However, it is far easier to adjust one
discount rate, rather than all the cash flows over a number of years.
This is particularly true where the cash flows are annuities, and the real method
is the only possible method where they are perpetuities. Although it is
theoretically possible to use the real method where the impact of taxation needs
to be incorporated, it is extremely complex. It is therefore much safer (and
easier) to use the money method.
Where all cash flows are subject to differing rates of inflation, the cash flows will
have to be individually restated as money flows and so the money rate will be
needed. Where all cash flows expressed in current (real) terms, the real rate will
be simplest.
11.6
Consulting fee paid to determine the long-term market viability of the products
made at the plant: Not relevant
Salaries of two plant managers who are to be reassigned to another plant: Not
relevant
Head office administration costs apportioned to the division: Not relevant
Annual recharge from the company maintenance division for the actual cost of
servicing the machinery within the plant: Relevant
Savings arising from the reduced level of buildings insurance that will be paid by
the company: Relevant
Income from the sale of the plant buildings: Relevant
Cost of recent redecoration of the staff areas within the plant, billed but not yet
paid for: Not relevant
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