- 10 Marks
FM – L2 – Q57 – DCF: Taxation and Inflation
Calculate the NPV of a project for CVB Ltd, considering tax, capital allowances, and cash flows over five years with a 15% cost of capital.
Question
CVB Ltd is considering whether to invest in new equipment costing GH¢600,000. The equipment is expected to have an economic life of five years and will have no disposal value at the end of Year 5 (and no disposal costs).
CVB’s after-tax cost of capital is 15%. Tax is charged at an annual rate of 35% and is payable in the year following the year in which the taxable profits arise.
The following forecasts relate to the project under consideration:
| Year | GH¢000 | ||||
|---|---|---|---|---|---|
| 1 | 2 | 3 | 4 | 5 | |
| Sales income | 250 | 250 | 300 | 350 | 400 |
| Direct materials | 50 | 55 | 58 | 64 | 70 |
| Direct labour | 25 | 25 | 30 | 30 | 35 |
| Total direct costs | 75 | 75 | 88 | 94 | 105 |
| Depreciation | 120 | 120 | 120 | 120 | 120 |
There will be tax allowances on the cost of the equipment, calculated at 25% each year on the reducing balance basis. The first depreciation tax allowance (capital allowance) would be claimed in year 0 (or very early in year 1).
Assume that:
(1) taxable profits are defined as income minus direct costs and capital allowances
(2) cash profits in each year = sales minus direct costs
Required
Calculate the net present value of the project and recommend whether or not the project should be undertaken.
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