ACF838: A Company Is Evaluating Two Mutually Exclusive Projects: Corporate Financial Management Assignment, NUI, Ireland

(a) A company is evaluating two mutually exclusive projects, only one of which will be accepted. The company’s cost of capital is 11%.

Option 1: Product X

This project will have a five-year life. The selling price per unit in the first year is expected to be £14.55. Materials and labor are expected to cost £3.30 and £7.20 per unit
respectively in the first year. The selling price and the cost of labor per unit are expected to increase by 6% per year in the third and subsequent years. Materials cost per
unit is expected to increase by 5% per year in the third and subsequent years.

80,000 units are expected to be produced and sold in the first year; in the second and subsequent years, this figure is expected to increase to 110,000 units. Investment in
working capital is expected to increase by £135,000 at the start of the project and will be reversed at the end of the project life.

The initial cost of £1,425,000 is to be paid now. Assets used in the project will have a useful life of five years, after which they will be sold on for a value of £75,000. The company will apportion per year £30,000 of its head office administrative costs to this project.

Option 2: Product Y

This project will have a three-year life. The company has already spent £80,000 on the design of this product. An initial outlay of £1,275,000 is to be paid now with a further £300,000 in one year’s time. The annual revenue is expected to be £1,110,000 in year 1 rising by £135,000 each subsequent year. Operational costs are expected to be £450,000 in year 1 rising by £112,500 each subsequent year.

At the end of the project, assets will be sold for a value of £375,000. Investment in working capital is expected to increase by £60,000 at the start of the project and will be
reversed at the end of the project life. The company will apportion per year £50,000 of its head office administrative costs to this project.

With regard to this project, some management will have to leave aside work on other projects, resulting in delays and reduced income from these projects amounting to
£75,000 per year.

(b) The following relates to a capital investment appraisal process for a company. Two alternative projects (options A and B) are being considered. The company explored these projects as they had vacant space in their factory. The projects are in the same line of business as the existing projects of the company.