1.

The directors of ABC Co are considering a planned investment project costing $25m, payable at the start of the
first year of operation. The following information relates to the investment project:
Year 1 Year 2 Year 3 Year 4
Sales volume (units/year)
520,000 624,000 717,000 788,000
Selling price ($/unit)
30.00 30.00 30.00 30.00
Variable costs ($/unit)
10.00 10.20 10.61 10.93
Fixed costs ($/year)
700,000 735,000 779,000 841,000
This information needs adjusting to take account of selling price inflation of 4% per year and variable cost inflation of
3% per year. The fixed costs, which are incremental and related to the investment project, are in nominal terms. The
year 4 sales volume is expected to continue for the foreseeable future.

ABC Co pays corporation tax of 30% one year in arrears. The company can claim tax-allowable depreciation on a 25%
reducing balance basis.

The views of the directors of ABC Co are that all investment projects must be evaluated over four years of operations,
with an assumed terminal value at the end of the fourth year of 5% of the initial investment cost. Both net present value
and discounted payback must be used, with a maximum discounted payback period of two years. The real after-tax cost
of capital of ABC Co is 7% and its nominal after-tax cost of capital is 12%.
Required
(a) (i) Calculate the net present value of the planned investment project. (9 marks)
(ii) Calculate the discounted payback period of the planned investment project. (2 marks)
(b) Discuss the financial acceptability of the investment project. (3 marks)
(c) Critically discuss the views of the directors on ABC Co's investment appraisal. (6 marks)
(Total = 20 marks)
2. Blueocean is a large company listed on a major stock exchange. In recent years, the board of Blueocean
has been criticised for weak corporate governance and two of the company’s non-executive directors have just
resigned. A recent story in the financial media has criticised the performance of Blueocean and claims that the
company is failing to satisfy the objectives of its key stakeholders.

Blueocean is appraising an investment project which it hopes will boost its performance. The project will cost $20
million, payable in full at the start of the first year of operation. The project life is expected to be four years. Forecast
sales volumes, selling price, variable cost and fixed costs are as follows:
Year 1 2 3 4
Sales (units/year) 300,000 410,000 525,000 220,000
Selling price ($/unit) 125 130 140 120
Variable cost ($/unit) 71 71 71 71
Fixed costs ($’000/year) 3,000 3,100 3,200 3,000
Selling price and cost information are in current price terms, before applying selling price inflation of 5% per year,
variable cost inflation of 3.5% per year and fixed cost inflation of 6% per year. Blueocean pays corporation tax of 26%,
with the tax liability being settled in the year in which it arises. The company can claim tax-allowable depreciation on
the full initial investment of $20 million on a 25% reducing balance basis.
The investment project is expected to have zero residual value at the end of four years. Blueocean has a nominal after-
tax cost of capital of 12% and a real after-tax cost of capital of 8%. The general rate of inflation is expected to be 3.7%
per year for the foreseeable future.
Required
(a) (i) Calculate the nominal net present value of Blueocean Co’s investment project. (8 marks)
(ii) Calculate the real net present value of Blueocean Co’s investment project and comment on your
findings. (4 marks)
(b) Discuss FOUR ways to encourage managers to achieve stakeholder objectives. (8 marks)
(Total = 20 marks)