ackhammer Ltd is a manufacturer of construction tools. Its management expects a small boom in construction in the coming years; however, the spectre of high inflation and the projects$$ risks are weighing upon their future planning sessions. Management wishes to expand production capacity; however, their current planning processes are not adequate to take the current inflationary environment into account. You were hired as a consultant to assist with the decision. Your first step was to consult with relevant stakeholders within Jackhammer Ltd regarding the expected sales that the project is expected to generate. After thoroughly taking all opinions into account, you summarised the information below:

Initial cost of the project $($Year $0)$: R$8$ million

Expected cash flows are as follows:

Year

$1$

$2$

$3$

Sales $($Rands$)$

$3$ million

$6$ million

$9$ million

You have also gathered the following information from the company accounts and some external sources:

$$ Inflation: $7\%$

$$ WACC: $15\%$

$$ Tax rate: $27\%$

$$ Write off period, $3$ years, using the straight line method

$$ Variable costs are equal to $10\%$ of the expected cash inflows

$$ There are no related incremental fixed costs expected

It is expected that at the end of the project$$s three$-$year life, the equipment that made up the initial costs, will be collected by a scrap company for R$500000($in nominal term, at the end of the $3$rd year$).$ The initial R$8$ million cost is related to the purchase of machinery and the installation thereof, and the entire amount, is depreciable over the write off period.

Required:

You further agreed to perform the following tasks:

a$.)$ The cash flows are presented in real terms, and you must determine their nominal values by inflating them utilising the inflation rate. $(3)$

b$.)$ Identify the relevant cash flows and tax effects of the project. $(9)$

c$.)$ Determine the NPV of the project using the WACC. $(2)$

d$.)$ Determine the NPV of the project if a risk premium of $5\%$ is added to the discount rate to account for inherent risk of the project. $(1)$

e$.)$ Prepare a report for Jackhammer Ltd$,$ detailing how you accounted for inflation and what effect not doing so would have had on the NPV$.$ Also, discuss the acceptability of the project, based on the two NPV$$s you calculated in $($c$)$ and $($d$),$ and provide the client with a recommendation based on your findings.