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Hi Sir,
There was a question in the exam regarding NPV where we had to calculate NPV in both nominal and real terms. The initial cost of the factory was $50m and the sales in units for years 1-4 were, 1m, 1.4m, 1.8m and 2m. From year 5 the production and sales would stay at 2m for the foreseeable future.
Contribution per unit was expected to be $12.75 and contribution inflation was 5%, fixed costs for running the factory were $1.5m the first year and expected to grow each year by 3%.
We can benefit from tax allowable depreciation on a straight line basis for the first 10 years of the assets life with tax charges being settled in the year in which they arise. Tax rate was 25%.
Nominal after-tax cost of capital was 10% with real after-tax cost of capital being 6%. General inflation was 4%.
How exactly are we supposed to go about this question? Do we calculate NPV till year 4 or to perpetuity? How do we account for inflation when calculating perpetuity in nominal terms?
Thanks sir.
I have not seen the exam because the ACCA have not published it yet, so without seeing the exact wording of the question I cannot be certain.
However from what you have written, you would calculate the PV for the first four years using the nominal cost of capital in the normal way. For 5 to infinity you would need to use the real cost of capital.
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