Intermediate: NPV calculation and taxation Data Tilsley Ltd manufactures motor vehicle com¬ ponents. 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 cumula¬ tive 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 follow¬ ing 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 lull 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 differ¬ ent from that produced by Helen Foster, the production director.
Notes:
Risk and inflation can be ignored.

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Year 1 2 3 4 (000) (000) (000) (000) Sales 8750 12 250 13300 14 350 Direct materials 1340 1875 2250 2625 Direct labour 2675 3750 4.500 5250 Direct overheads 185 250 250 250 Depreciation 2500 2500 2500 2500 Interest 1012 1012 1012 1012 Profit before tax 1038 2863 2788 2713 Corporation tax @ 30% 311 859 836 814 Profit after tax 727 2004 1952 1899