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 🙂 )

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

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.

Daemane says

Sir i did not understand and where you said at the interest of 5% the NPV will be -8820 if i am right

John Moffat says

I did not say that! The difference between +6,660 and -2,160 is 8,820.

Ahaisibwe says

Hey Joseph…I thought a decrease from 6,660 to 2,160 would be 4,500…how does it come to be 8820.

Ahaisibwe says

Sorry, my bad…hadn’t followed through properly

John Moffat says

No problem – I trust that you are now OK with it 🙂

ZainabM21 says

hi sir for example 1, I got negative 6660. 80000 -18180 – 2478-0 – 30040 – 13660 = -6660

John Moffat says

The 80,000 is an outflow and so is negative. The other flows are inflows and are positive.

The net total is therefore positive.

ZainabM21 says

ohh okay got it ! thank you so much for the help. your lectures are great!

Drametu says

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.

John Moffat says

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 🙂 )

kamo7293 says

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

John Moffat says

🙂

Hiền says

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.

John Moffat says

Calculation of the WACC is not in the syllabus for Paper MA !! It is not examined until later papers.