5(a) - Candidates were required here to calculate the expected net present value (ENPV) of an investment project and to comment on its financial acceptability. Most answers gained good marks.

The selling price was forecasted to depend on the future state of the economy and most answers correctly used the probabilities of the future economic states to calculate an average selling price.

Some answers, however, wasted valuable time by calculating an NPV for each the economic states. The question gave the forecast total nominal variable costs, which some candidates incorrectly inflated. Nominal values, of course, include inflation.

Although the question stated that tax liabilities were paid in the year they arose, some answers incorrectly deferred the tax liabilities by one year.

Credit was given for tax benefits arising from tax-allowable depreciation whether the effect of the scrap value was accounted for in the final year of operation or on an average basis over the life of the investment project (the method used in the suggested answer), provided a straight-line approach was adopted.

Some answers incorrectly used a 25% reducing balance approach to tax-allowable depreciation.

While the suggested answer uses tax benefits arising from tax-allowable depreciation, credit was also given where tax-allowable depreciation was subtracted to give taxable profit, then added back after the tax liability had been calculated.

The after-tax cash flow would be the same irrespective of which approach were adopted. Some answers incorrectly treated tax-allowable depreciation as a positive cash flow.

Credit was given for including the scrap value whether it was placed in the fourth year or the fifth year, although the question did say that it was expected to arise at the end of four years.

Even though the question required candidates to calculate the ENPV, many answers commented on financial acceptability by stating that the NPV of the investment project was positive and therefore it was financially acceptable.

This ignores the fact that the ENPV is an average NPV which is not expected to occur in practice. An average NPV might also include a negative NPV in its calculation.

A key learning point here is the need to read the question carefully, not just in order to clearly understand the question requirement, but also to understand the information provided by the question.