Tesco plc is contemplating introducing a new computer system which it is believed will streamline its supply chain activities. The major savings will occur due to the more efficient movement of goods between suppliers, Tesco central depots and Tesco stores. The new system has been proposed by staff at the Cheshunt Head Office.

The initial investment in the Computer Project would require an outlay of £14.5 million. The following cash flows related to the project (in current terms) are then predicted to arise over the next five years (which has been selected as a prudent time span over which to build an investment model due to the obsolescence factor of IT systems):

It is anticipated that over the next 5 years:

· Inflation on Cash Savings will be 6% per annum

· Inflation on Cash Outflows will be 4% per annum

· The general rate of inflation in the economy will be 5% per annum.

The central finance team predicts an annual tax rate of 28% on the net cash flows over the 5 years and the team is aware that the investors will require an overall after tax REAL rate of return of 10.5%.

Required:

a) Calculate the Net Present Value (NPV) and Internal Rate of Return (IRR) of the proposed investment in the computer project, taking into account the impact of inflation and taxation (there are no capital allowances available and tax is payable in the year of the net cash flow). You should also provide a brief comment on your answer indicating whether or not the investment is financially worthwhile.

b) Christine Lampard, a Manager at the Welwyn Garden City Head Office indicates that she and her assistant, Aditya Deokar (who studied finance at undergraduate level) have been looking at an alternative computer project and which confusingly, upon investigation, has a lower NPV and higher IRR, than the Project recommended by the Cheshunt Head Office. Therefore, they are not sure how this is possible or which methodology they should follow.

You are required to provide a considered response to their query.