Global Corporate Accounting
Global Corporate Accounting
ACFI 3050
Revision Pack – Questions
(Investment Appraisal)
April 2021
Question 1
A manufacturing company based in the UK is considering an overseas investment in Bellota, a politically stable country. It will initially cost
B$12m and is expected to earn post-tax cash flows of:
Year B$’000
1 2,500
2 3,900
3 4,500
4 6,700
Real interest rates in the two countries are the same and are expected to remain the same in the future.
The current spot rate is B$2.5000 / £1.
The risk-free rate of interest in Bellota is 3% and in the UK is 5%.
The company requires a sterling return of 10% from the investment.
Required:
- Calculate the £ sterling NPV of the investment, by discounting the annual cash flows in £ sterling.
Question 2
Spot Ltd is a UK based company. It is considering a three-year project in Nolland. The project will require an initial investment of N80m and this will have a resale value at the end of the third year of N10 million.
Writing down allowances are available at 25% on the reducing balance basis.
The projects pre-tax net inflows are expected to be:
Year 1 N 35 million
Year 2 N 80 million
Year 3 N 50 million
The current spot rate is N5 / £1.
UK inflation is expected to be 2% per annum and Nolland inflation is expected to be 4% per annum.
Nolland’s tax rate is 20% and is payable one year in arrears.
The UK tax rate is 30% and payable one year in arrears.
Spot Ltd uses a discount rate of 10%.
Required:
Calculate the NPV of the project in £ and state whether it should be accepted or rejected.
Show all your workings.
Question 3
A Plc. is a company based in the UK. It is considering a project investment in North America including the acquisition of new machinery which it hopes will increase its profits.
The initial investment in machinery would be $25 million immediately and the project is expected to last for three years.
Investment in machinery receives tax allowable depreciation of 25% per annum (on a straight-line basis). Allowances are receivable in the same year.
The machinery will be sold at the end of the project for $7 million, in year 3 prices.
Sales are estimated to be $10 million per annum in current terms. Sales prices are expected to rise by 2% per annum.
Purchases of raw materials and labou are expected to be $2 million each in current terms, but expected to rise by 3% and 5% respectively.
Corporation tax in the UK is 30% payable in the following year and in North America corporation tax is 30% payable in the same year.
The project will require an injection of working capital immediately of $10 million and will be released at the end of the project. The working capital requirement is expected to rise by 5% per annum.
The nominal cost of capital of A Plc. is 10%. General inflation in the UK is predicted to be 5% per annum, and in North America is 2%, throughout the duration of the project.
The current spot rate for the £ to the $ is £1 = $1.8000.
Required:
Calculate the annual discounted cash flows in £ millions, using the nominal rate method. (Use 3 decimal places where possible in your calculations.)
State the net present value of the project and whether you recommend for the project to commence.
Question 4
- Explain the importance of using more than one method to examine risk is project appraisal.
- Why is net present value method of investment appraisal considered to superior to other methods?
- Why are cash flows rather than profit used for IRR, NPV and payback period methods of investment appraisal?
- Choose the correct words from those in highlighted.
Tax allowable depreciation is used to increase/ reduce taxable profits, and the consequent reduction in the payment should be treated as cash saving/ cash payment arising from acceptance of the project. When plant or equipment is eventually sold, the difference between the sales price and the reducing balance amount is treated as a taxable profit/ tax allowable loss if the sales price exceeds the reducing balance and as a taxable profit/ tax allowable loss if the reducing balance exceeds the sales loss.
- If cashflows are expressed in terms of the actual number of pounds that will be received or paid on various future dates, should nominal rate or real rate be used for discounting?
Question 5
Ajay Plc is considering whether or not to invest in the new project that will have an expected life of 4 years. The managing director’s estimates for the project are as follows:
Year | 0 | 1 | 2 | 3 | 4 |
£000 | £000 | £000 | £000 | £000 | |
Cost of machinery |
2,000 | ||||
Cash Inflow | |||||
Sales |
2,500 | 3,000 | 3,500 | 3,500 | |
Cash Outflow | |||||
Materials cost |
500 | 600 | 700 | 700 | |
Labour costs |
750 | 900 | 1,100 | 1,100 | |
Overheads |
300 | 350 | 350 | 350 | |
Depreciation |
400 | 400 | 400 | 400 | |
Total Costs | 1,950 | 2,250 | 2,550 | 2,550 | |
Profit | 550 | 750 | 950 | 950 |
Additional Information:
- Corporation tax on taxable profits is payable at 20%, one year in arrears.
- Selling prices and overhead expenses will increase with inflation at 5% per annum.
- Materials cost and labour costs will increase at 10% per annum.
- Capital allowances will be available against taxable profits of the project at 18% per annum on a reducing balance method.
- The machine has zero scrap value at the end of the project’s life.
- The company’s nominal after-tax weighted average cost of capital is 10%.
Required:
Estimate the net present value (NPV) of the project, and advise whether the project should be undertaken.
ACFI 3050
Revision Pack – Questions
(Investment Appraisal)
April 2021
Question 1
A manufacturing company based in the UK is considering an overseas investment in Bellota, a politically stable country. It will initially cost
B$12m and is expected to earn post-tax cash flows of:
Year B$’000
1 2,500
2 3,900
3 4,500
4 6,700
Real interest rates in the two countries are the same and are expected to remain the same in the future.
The current spot rate is B$2.5000 / £1.
The risk-free rate of interest in Bellota is 3% and in the UK is 5%.
The company requires a sterling return of 10% from the investment.
Required:
- Calculate the £ sterling NPV of the investment, by discounting the annual cash flows in £ sterling.
Question 2
Spot Ltd is a UK based company. It is considering a three-year project in Nolland. The project will require an initial investment of N80m and this will have a resale value at the end of the third year of N10 million.
Writing down allowances are available at 25% on the reducing balance basis.
The projects pre-tax net inflows are expected to be:
Year 1 N 35 million
Year 2 N 80 million
Year 3 N 50 million
The current spot rate is N5 / £1.
UK inflation is expected to be 2% per annum and Nolland inflation is expected to be 4% per annum.
Nolland’s tax rate is 20% and is payable one year in arrears.
The UK tax rate is 30% and payable one year in arrears.
Spot Ltd uses a discount rate of 10%.
Required:
Calculate the NPV of the project in £ and state whether it should be accepted or rejected.
Show all your workings.
Question 3
A Plc. is a company based in the UK. It is considering a project investment in North America including the acquisition of new machinery which it hopes will increase its profits.
The initial investment in machinery would be $25 million immediately and the project is expected to last for three years.
Investment in machinery receives tax allowable depreciation of 25% per annum (on a straight-line basis). Allowances are receivable in the same year.
The machinery will be sold at the end of the project for $7 million, in year 3 prices.
Sales are estimated to be $10 million per annum in current terms. Sales prices are expected to rise by 2% per annum.
Purchases of raw materials and labou are expected to be $2 million each in current terms, but expected to rise by 3% and 5% respectively.
Corporation tax in the UK is 30% payable in the following year and in North America corporation tax is 30% payable in the same year.
The project will require an injection of working capital immediately of $10 million and will be released at the end of the project. The working capital requirement is expected to rise by 5% per annum.
The nominal cost of capital of A Plc. is 10%. General inflation in the UK is predicted to be 5% per annum, and in North America is 2%, throughout the duration of the project.
The current spot rate for the £ to the $ is £1 = $1.8000.
Required:
Calculate the annual discounted cash flows in £ millions, using the nominal rate method. (Use 3 decimal places where possible in your calculations.)
State the net present value of the project and whether you recommend for the project to commence.
Question 4
- Explain the importance of using more than one method to examine risk is project appraisal.
- Why is net present value method of investment appraisal considered to superior to other methods?
- Why are cash flows rather than profit used for IRR, NPV and payback period methods of investment appraisal?
- Choose the correct words from those in highlighted.
Tax allowable depreciation is used to increase/ reduce taxable profits, and the consequent reduction in the payment should be treated as cash saving/ cash payment arising from acceptance of the project. When plant or equipment is eventually sold, the difference between the sales price and the reducing balance amount is treated as a taxable profit/ tax allowable loss if the sales price exceeds the reducing balance and as a taxable profit/ tax allowable loss if the reducing balance exceeds the sales loss.
- If cashflows are expressed in terms of the actual number of pounds that will be received or paid on various future dates, should nominal rate or real rate be used for discounting?
Question 5
Ajay Plc is considering whether or not to invest in the new project that will have an expected life of 4 years. The managing director’s estimates for the project are as follows:
Year | 0 | 1 | 2 | 3 | 4 |
£000 | £000 | £000 | £000 | £000 | |
Cost of machinery |
2,000 | ||||
Cash Inflow | |||||
Sales |
2,500 | 3,000 | 3,500 | 3,500 | |
Cash Outflow | |||||
Materials cost |
500 | 600 | 700 | 700 | |
Labour costs |
750 | 900 | 1,100 | 1,100 | |
Overheads |
300 | 350 | 350 | 350 | |
Depreciation |
400 | 400 | 400 | 400 | |
Total Costs | 1,950 | 2,250 | 2,550 | 2,550 | |
Profit | 550 | 750 | 950 | 950 |
Additional Information:
- Corporation tax on taxable profits is payable at 20%, one year in arrears.
- Selling prices and overhead expenses will increase with inflation at 5% per annum.
- Materials cost and labour costs will increase at 10% per annum.
- Capital allowances will be available against taxable profits of the project at 18% per annum on a reducing balance method.
- The machine has zero scrap value at the end of the project’s life.
- The company’s nominal after-tax weighted average cost of capital is 10%.
Required:
Estimate the net present value (NPV) of the project, and advise whether the project should be undertaken.