Candidates were asked here to calculate the net present value (NPV) of a project being evaluated by Ridag Co, taking account of inflation and taxation, and to comment on its financial acceptability. Most answers gained good marks on this question.

Some student encountered difficulty including inflation in their NPV calculation. Inflation, like interest, compounds forward through time, with a compounding effect. One year’s inflation is therefore to be applied to year 1 figures, two years’ inflation is to be applied to year 2 figures and so on. Too often, answers applied one year’s inflation to every year’s figures.

Most answers handled correctly the instruction to pay profit tax one year in arrears. Capital allowances and their tax benefits were usually handled well also, although not all answers handled correctly the capital allowance/balancing allowance for the final year of operation. Some answers used a different timing for the tax liabilities compared to the capital allowance tax benefits, but this was not correct.

Since nominal after-tax cash flows were being discounted in the NPV calculation, the nominal after-tax weighted average cost of capital of 7% had to be used as the discount rate. The rule to remember here is “discount like with like”

The mark for the comment on financial acceptability was a relatively easy mark to earn, and most answers made a suitable comment following the NPV calculation.