Pakistan Windmills Company Limited (PWCL) is evaluating an investment proposal that has an expected life of five years and will not be repeated. The initial investment, payable at the start of the first year of operation, is $6,000,000. Scrap value of $600,000 is expected to arise at the end of five years.

There is some uncertainty about what price can be charged for the units produced by the investment project, as this is expected to depend on the future state of the economy. The following forecast of selling prices and their probabilities has been prepared:

Future economic state Weak Medium Strong

Probability of future economic state 30% 45% 25%

Selling price in current price terms $25 per unit $30 per unit $35 per unit

These selling prices are expected to be subject to annual inflation of 4% per year, regardless of which economic state prevails in the future.

Forecasted sales and production volumes, and total nominal variable costs, have already been forecast, as follows:

Year 1 2 3 4 5

Sales & prod. (000 units) 150 250 400 460 350

Variable cost ($000) 2,385 4,200 7,080 6,480 4,900

Incremental overheads of $350,000 per year in current price terms will arise as a result of undertaking the investment project. A large proportion of these overheads relate to energy costs which are expected to increase sharply in the future because of energy supply shortages, so overhead inflation of 10% per year is expected.

The initial investment will attract tax-allowable depreciation on a straight-line basis over the five-year project life. The rate of corporation tax is 30% and tax liabilities are paid in the year in which they arise. PWCL has traditionally used a nominal after-tax discount rate of 12% per year for investment appraisal.

Required:

Prepare a fully automated Excel spreadsheet to calculate the expected net present value of the investment project and comment on its financial acceptability.