In Problem 5, FIFO is the basis of the cost of goods sold in taxable income. The corporate tax rate is 30%.

(a) If the rate of inflation is 10%, what is the tax effect in each of the next three years of the inventory investment?

(b) Does this tax effect increase or reduce the NPV of the project?

Data From Problem 5:-

The working capital investment in a project initially is €2.5 million. Of this, inventory represents €1.5 million. Cash, debtors, and creditors represent the remaining €1million.

(a) If the expected rate of inflation is 10%, how much more investment in working capital is required in each of the next three years?

(b) If the expected rate of inflation increases, will the effect of this working capital investment increase or reduce the NPV of the project?