FM march june 2019 specimen paper no 32 a (ii)

Pinks Co is a large company listed on a major stock exchange. In recent years, the board of Pinks Co has been criticised for weak corporate governance and two of the company’s non-executive directors have just resigned. A recent story in the financial media has criticised the performance of Pinks Co and claims that the company is failing to satisfy the objectives of its key stakeholders. Pinks Co is appraising an investment project which it hopes will boost its performance. The project will cost $20m, payable in full at the start of the first year of operation. The project life is expected to be four years. Forecast sales volumes, selling price, variable cost and fixed costs are as follows: Year 1 2 3 4
Sales (units/year) 300,000 410,000 525,000 220,000
Selling price ($/unit) 125 130 140 120
Variable cost ($/unit) 71 71 71 71
Fixed costs ($’000/year) 3,000 3,100 3,200 3,000 Selling price and cost information are in current price terms, before applying selling price inflation of 5% per year, variable cost inflation of 3·5% per year and fixed cost inflation of 6% per year. Pinks Co pays corporation tax of 26%, with the tax liability being settled in the year in which it arises. The company can claim tax-allowable depreciation on the full initial investment of $20m on a 25% reducing balance basis. The investment project is expected to have zero residual value at the end of four years. Pinks Co has a nominal after-tax cost of capital of 12% and a real after-tax cost of capital of 8%. The general rate of inflation is expected to be 3·7% per year for the foreseeable future.
Required: (a) (i) Calculate the nominal net present value of Pinks Co’s investment project. (8 marks)
(ii) Calculate the real net present value of Pinks Co’s investment project and comment on your findings. (4 marks)

Please explain how the real tax flow figures before tax are reached my learning provider would not help as it was not in their notes. How petty!! thank you

Real terms appraisal of the investment project
Year 1 2 3 4 $000 $000 $000 $000
Nominal cash flows before tax
14,148 24,097 39,948 10,379
Real cash flows before tax 13,643 22,408 35,823 8,975
Tax at 26% (3,547 ) (5,826 ) (9,314 ) (2,334 )
TAD benefits 1,300 975 731 2,194
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Cash flows after tax 11,396 17,557 27,240 8,835
Discount at 8% 0·926 0·857 0·794 0·735
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Present values 10,553 15,046 21,629 6,494
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