Candidates were required to calculate the net present value (NPV) of an investment project in nominal terms and to comment on its financial acceptability. Most candidates did well on this question. Correct answers produced a slightly negative NPV.

Most candidates dealt with operating cash flows (sales income, variable cost and fixed cost) at the start of their calculation and dealt at a later stage with other cash flows (tax and capital items). This approach helps to avoid errors in the tax treatment of cash flows.

Both sales income and variable cost were occasionally inflated wrongly, for example by inflating each year’s cash flows by only one year’s inflation. In fact, year two cash flows need inflating for two years, year three cash flows need inflating for three years, and so on, because inflation has a compounding effect. More rarely, some candidates dealt with annual fixed cost as though it were fixed cost per unit.

Some candidates wrongly classified scrap value as income subject to corporation tax, leading to an error in their tax calculations. Credit was given for including scrap value whether it was taken as a year four or year five cash flow.

Most candidates calculated corporation tax liabilities separately from the tax benefits given by tax-allowable depreciation. Many calculations were entirely correct. Errors that were found included:

• using 30% corporation tax, when the question specified 28% corporation tax; 
• failing to put tax liabilities and tax benefits one year in arrears; 
• failing to allow for scrap value when calculating tax-allowable depreciation for the final year.

Most candidates correctly used the nominal after-tax cost of capital provided as the discount rate in their NPV calculation and did not try to amend it.

A comment on the financial acceptability of Project E was required and where the NPV was negative most candidates correctly cited this as financial grounds for rejection. Better answers noted that the board of directors required this project to be undertaken regardless of its financial acceptability.