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Kaplan Study Text Section C – Sludgewater Q22

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Kaplan Study Text Section C – Sludgewater Q22

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  • July 30, 2022 at 9:23 pm #662114
    ishika8
    Participant
    • Topics: 2
    • Replies: 2
    • ☆

    Hello Sir,
    Sludgewater, a furniture manufacturer, has been reported to the antipollution authorities on several occasions in recent years, and fined
    substantial amounts for making excessive toxic discharges into the air.
    Both the environmental lobby and Sludgewater’s shareholders have
    demanded that it clean up its operations.
    If no clean up takes place, Sludgewater estimates that the total fines it
    would incur over the next three years can be summarised by the
    following probability distribution (all figures are expressed in present
    values).
    Level of fine Probability
    $1.0m 0.3
    $1.8m 0.5
    $2.6m 0.2
    A firm of environmental consultants has advised that spray painting
    equipment can be installed at a cost of $4m to virtually eliminate
    discharges. Unlike fines, expenditure on pollution control equipment is
    tax-allowable via 25% tax-allowable depreciation (reducing balance,
    based on gross expenditure).
    The rate of corporation tax is 30%, paid with a one-year delay. The
    equipment will have no scrap or resale value after its expected three
    year working life. The equipment can be in place ready for
    Sludgewater’s next financial year.
    A European Union grant of 25% of gross expenditure is available, but
    with payment delayed by a year. The consultant’s charge is $200,000
    and the new equipment will raise annual production costs by 2% of
    sales revenue. Current sales are $15 million per year, and are
    expected to grow by 5% per year compound. No change in working
    capital is envisaged.
    Sludgewater applies a discount rate of 10% after tax on investment
    projects of this nature. All cash inflows and outflows occur at year ends.
    Required:
    (a) Assess the proposed investment by calculating the expected net
    present value.

    My doubt is that why have they not included incremental Sales revenue and the tax in the solution when calculating expected NPV and why is the tax allowance starting from year 0, we usually do it from year 1 and why is there tax allowance on 1.687 whereas we usually subtract sales proceeds from 2.25 which are 0 here so the entire allowance should be on 2.25. I am confused. Please help me with the same.

    Thank you.

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