Wednesday, May 18, 2011

The Tax benefits~

Is tax good? Well, it fully depends on the policy written in the law. Whenever we say tax, normally and casually, it doesn’t give much good sense, as it means a “payment”.

Entertainment tax, government tax, service tax... wow! the bills... However, a good citizen may choose to say : I love tax! Ya right, go for it dude! So how tax impact our living? Some expenses are tax deductible, and for that reason, be smart in filling up the form! When I was in the course of principle of Malaysian Taxation in UUM, I was taught of how to compute the tax payable. That’s interesting.

Now, putting it into the field of finance, in finance, we emphasize on tax too because tax benefits give rises to the NPV of a project. Assuming a 5-years project was valuated its NPV of (1000) if full equity financing is used. This project should be rejected, a rational financial analyst may say.
However, would changes happen if partial of the financing were sourced from loan?

To account that:
Suppose a company decided to borrow RM30000 at 10% interest rate to be part of the financing sources. Here, the NPV of the loan would be:

NPV of loan=Loan received-(PV of taxed interest payment)- PV of loan
NPV of loan=RM30000-RM1980 {(1-1/((1+0.1)^5))(1/0.1) }- (RM30 000)/((1.1)^5)
This NPV value reflects the tax benefits on interest paid.
To prove that: in the event of no tax,
NPV of loan=RM30000-RM3000 {(1-1/((1+0.1)^5))(1/0.1) }- (RM30 000)/((1.1)^5)

Note: Assuming no floatation cost, tax rate is 34%
In time value of money, whatever received in future is always valued at lower than whatever received today. The RM30 000 received today can be highly beneficial to the borrower, because he/she can use the money now for profitable investment income and repay the money in full later. However, the lender NOT STUPID too, they charged interest on the loan received. Thus, the interest paid inclusive of the element of “discounting factor and risks”, the risks refer to the uncertainty of repayment on borrower or some unforeseen events in future. Thus, The RM30000 received is positive and the remaining two items are negative.

So, why the final summation is in positive? Refer first equation. That’s because of the tax deductibility on interest payment.

Remember EBIT? Tax payment is calculated after deduction of interest payment. If no interest, means higher EBT, which means more tax. If interest exists, means lower EBIT, and lower tax. Huh... lower EBT? does that means my position as equity holder receives lesser??

The different of the two is the tax benefit of interest. So eventually, the NPV of loan becomes positive.

haha... when a firm raise funds through debt financing, the residual net profit, will be distributed to FEWER equity holders. On the contrary, when a firm raise funds through equity financing, for example, issuing common stocks, the residual net profit, will be distributed to more equity holders. so, bigger pie but more slices VS smaller pie but lesser slice.

You see, the loan borrowed must be repaid, through interest and principal in full. However, when both were fully paid, the NPV of loan should equal to zero, but why residual positive? That’s because tax exemption happens on every interest payment we made.
So, is debt financing good? That depends on our risk attitude. Debt increases firm’s value through tax benefits but decreases in value through bankruptcy.where the scale lies? hump...

Tuesday, May 10, 2011

the downside

whenever i put an extreme hope on something and when the odd goes to me, i collapse completely, like a mountain being boomed into pieces when the red button was pressed. di..di..di.."BOOM"... or like an ice ball being thrown into the wall and got smashed into pieces eventually. Hate it that way!

If... hey dude, be practical, no such thing as "if" in this world, if it does, we are living peacefully and happily ever after! and as a result, you wouldn't hearing people shouting some classical idioms such as :

1. what the F*** ( most rated)
2. Holy S***

People tend to give excuses starting with the word of "IF" and from here, we know they are giving us the excuses to excuse them from any blames or responsibilities or wrong act or shall i say in a more pleasant and informal way, "mis-act".

" I tell you ar, IF... then..." come on! just take it and live up with the painful lessons learned in the painful way. I know it hurts, but, does the hurt worthwhile? it depends on what corrective actions you took thereafter and what result produced. So just live with it!!!

note: i am on a therapy with myself (when writing this) for the bad exam i just went through. That was completely F***ing shit way i have ever had. I have underestimated the paper and have foregone the opportunity of scoring an apple. What a damn! Shit x3 !

what if... ... no way, ain't going to use that! may the best of the best go with me. gambateh n never give up. (although is easier to say than done, but that shall be the most i can do to counter the pain of my heart).