You are the chief accountant of Deighton plc, which manufactures a wide range of building and plumbing fittings. It has recently taken over a smaller unquoted competitor, Linton Ltd. Deighton is currently checking through various documents at Linton's head office, including a number of investment appraisals. One of these, a recently rejected application involving an outlay on equipment of £900,000, is reproduced below. It was rejected because it failed to offer Linton's target return on investment of 25 per cent (average profit-to-initial investment outlay).

Closer inspection reveals several errors in the appraisal.

Evaluation of profitability of proposed project NT17 (all values in current year prices)

You discover the following further details:
1 Linton's policy was to finance both working capital and fixed investment by a bank overdraft. A 12 per cent interest rate applied at the time of the evaluation.
2 A 25 per cent writing-down allowance (WDA) on a reducing balance basis is offered for new investment. Linton's profits are sufficient to utilise fully this allowance throughout the project.
3 Corporation tax is paid a year in arrears.
4 Of the overhead charge, about half reflects absorption of existing overhead costs.
5 The market research was actually undertaken to investigate two proposals, the other project also having been rejected. The total bill for all this research has already been paid.
6 Deighton itself requires a nominal return on new projects of 20 per cent after taxes is currently ungeared and has no plans to use any debt finance in the future.
Required
Write a report to the finance director in which you:
(a) Identify the mistakes made in Linton's evaluation.
(b) Restate the investment appraisal in terms of the post-tax net present value to Deighton, recommending whether the project should be undertaken or not.

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Item (0000) 0 4 1,400 ,600 1,800 1,000 (400) 450) (500) (250) (400) 450) (500) (250) (100) (100) 100 (100) (120) (120) 120 (120) (225) (225) (225 (225) Direct labour Overheads Depreciation Profit pre-tax Tax at 33% Post-tax profit Average prft £138 Rate of return- 11.5% Investment £1,200