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Investment Appraisal – NPV, IRR – ACCA Management Accounting (MA)

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  5. a) Project E is a strategically important project which the board of the TM Co have decided should be undertaken in order for the company to remain competitive. Information relating to the future cash flows of this project are as follows:
    Year 1 2 3 4
    Sales volume (units) 12,000 13,000 10,000 10,000
    Selling price ($per unit) 450 470 500 500
    Variable Cost ($per unit) 260 280 295 320
    Fixed costs (‘000) 750 750 750 750
    These forecasts are before taking into account of selling price inflation of 5.5% per year, Variable cost inflation of 6.5% per year and fixed cost inflation of 3% per year. The fixed costs are incremental fixed costs which are associated with project E. At the end of four years, machinery from the project will be sold for scrap with a value of $400,000. Tax allowable depreciation on the initial investment cost of the project is available on machinery at 25% reducing balance basis and the Company pays corporation Tax of 30% per year, one year in arrears. A balancing charge or allowance is available at the end of the four years of operation. The Company has a nominal after-tax cost of capital of 13% per year. The initial investment for Project E is $5,000,000
    Required:
    Calculate the Net Present Value (nominal after-tax NPV) of project E and comment on the financial acceptability of the project.

    • There is no point whatsoever in typing out a full question here and expecting to be provided with a full answer. This is for comments on the actual lecture!!!

      Ask in the Ask the Tutor Forum, but again there is no point in simply expecting me to provide a full answer. You must have an answer in the same book in which you found the question and so ask (in the Ask the Tutor Forum) about whatever it is you are not clear about in the answer, and I will explain. (If you do not have an answer because you have been given this as an assignment, then obviously we are not going to do your homework for you 🙂 )

  6. To sate my curiosity, I redid Example 1 with the interest rate at 13.78% and the final NPV I got was -160. obviously that came from rounding error. Just wanted to post it since I was expecting you to do it just to prove it really did make NPV 0

  7. Hi all, I have a question related to the impact of Working capital interest expense on the NPV calculation. From what I’ve learned, normally we will use the post-tax interest rate of long-term liabilities to calculate the WACC which will be used to discount the cashflow to generate the NPV, and the interest expense will be excluded from the cashflow calculation. However, I don’t know what is the treatment of interest expense on the working capital. In ACCA test kits, normally they ignore the interest expense which we have to pay for acquiring additional WC, they neither include such expense in cashflow calculation nor the WACC. What if the working capital contributes a large part of finance needed, a commodity trading company for example. What should we do? Put the interest expense to cashflow calculation and remove it from WACC or should we use it to calculate WACC? If the latter option is selected, how do we calculate WACC since the additional WC may vary over the time.

    Your answer is greatly appreciated.

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