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Project E (6/14, amended)

Project E is a strategically important project which the board of OAP Co has decided must be undertaken in order for the company to remain competitive, regardless of its financial acceptability. The project has a life of four years. Information relating to the future cash flows of this project are as follows:

Year

1

2

3

4

Sales volume (units)

12,000

13,000

10,000

10,000

Selling price ($/unit)

450

475

500

570

Variable cost ($/unit)

260

280

295

320

Fixed costs ($'000)

750

750

750

750

These forecasts are before taking into account of selling price inflation of 5.0% per year, variable cost inflation of 6.0% per year and fixed cost inflation of 3.5% per year. The fixed costs are incremental fixed costs which are associated with Project E. At the end of 4 years, machinery from the project will be sold for scrap with a value of $400,000. Tax-allowable depreciation on the initial investment cost of Project E is available on a 25% reducing balance basis and OAP Co pays corporation tax of 28% per year, one year in arrears. A balancing charge or allowance is available at the end of the fourth year of operation.

OAP Co has a nominal after-tax cost of capital of 13% per year. The initial investment for Project E is $5,000,000

Required

A. Calculate the nominal after-tax net present value of Project E and comment on the financial acceptability of this project.
B. Discuss the reasons why the board of OAP Co may decide to limit the funds that are available to finance projects.

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