In a telecom and media LBO, tax depreciation runs ahead of book depreciation. Build book tax against cash tax, the deferred tax liability over three years, and show what it does to free cash flow and returns.

Cash tax runs Rs 15 crore a year below book tax, so free cash flow is Rs 15 crore higher and a deferred tax liability of Rs 45 crore builds over three years. Modelled on cash tax, exit equity is Rs 1,517 crore, 1.52x and 14.9% IRR, against 13.7% on book tax. If the buyer treats the liability as debt, most of that gain goes back.

Because the accounts and the tax return depreciate the same network at different speeds. Think of a phone you expect to use for five years: you might mentally spread its cost evenly, but a scheme that let you claim most of it in year one would put cash in your pocket now. Tax depreciation of Rs 160 crore against book depreciation of Rs 100 crore lowers taxable profit by Rs 60 crore, and at 25% that is Rs 15 crore of tax paid later rather than now. The accounts still show the full book tax, and record the unpaid part as a deferred tax liabilityTax that the accounts say has been incurred but that the tax return has not yet required, because tax deductions ran ahead of accounting expenses. It reverses when they fall behind..

Year 1 shows it most simply. Interest is 8% of Rs 1,000 crore, Rs 80 crore. Book profit before tax is 250 less 100 less 80, Rs 70 crore, so book tax is Rs 17.5 crore; taxable profit is 250 less 160 less 80, Rs 10 crore, so cash tax is Rs 2.5 crore. Free cash flow is 250 less 2.5 less 80 less 120, Rs 47.5 crore, not the Rs 32.5 crore a book-tax model shows. Every year the extra Rs 15 crore repays debt, which then saves interest, so the gap in debt widens slightly to Rs 47.8 crore by exit.

It depends on whether it will reverse. Faster tax depreciation does not reduce total tax; it moves it. When the network's tax depreciation runs out and book depreciation continues, cash tax rises above book tax and the liability is paid. A buyer who expects that soon will argue the Rs 45 crore is debt-like and cut the price. But Nakshatra spends Rs 120 crore a year, more than its book depreciation; while the network keeps growing, new assets keep generating fresh accelerated deductions and the liability may never fall. That is the argument the seller makes.

So the close for an interviewer: model cash tax, show the liability, and state your exit assumption. Here the timing is worth about one point of IRR, 14.9% against 13.7%, and whether you keep it depends on the next owner's capex plan.