NPV calculation and taxation

Data

Tilsley Ltd manufactures motor vehicle components. It is considering introducing a new product. Helen Foster, the production director, has already prepared the following projections for this proposal:

Helen Foster has recommended to the board that the project is not worthwhile because the cumulative after tax profit over the four years is less than the capital cost of the project.

As an assistant accountant at the company you have been asked by Philip Knowles, the chief accountant, to carry out a full financial appraisal of the proposal. He does not agree with Helen

Foster's analysis, and provides you with the following information:

• the initial capital investment and working capital will be incurred at the beginning of the first year. All other receipts and payments will occur at the end of each year.
• the equipment will cost 10 million;
• additional working capital of £1 million;
• this additional working capital will be recovered in full as cash at the end of the four-year period;
• the equipment will qualify for a 25% per annum reducing balance writing down allowance;
• any outstanding capital allowances at the end of the project can be claimed as a balancing
• allowance;
• at the end of the four-year period the equipment will be scrapped, with no expected residual value;
• the additional working capital required does not qualify for capital allowances, nor is it an allowable expense in calculating taxable profit;
• Tilsley Ltd pays corporation tax at 30% of chargeable profits;
• there is a one-year delay in paying tax;
• the company's cost of capital is 17%.

Task

Write a report to Philip Knowles. Your report should:

(a) evaluate the project using net present value techniques;

(b) recommend whether the project is worth-while;

(c) explain how you have treated taxation in your appraisal;

(d) give three reasons why your analysis is different from that produced by Helen Foster, the production director.

Notes:

Risk and inflation can be ignored.