Bisket pk, a very large food processing company is considering a £6m. investment in one of its baked products factories. The cost includes purchase and installation of the equipment but excludes the training of operatives during the first year of operation. Training will be done on a rota basis and will cost £0.75m.
Acceptance of the project is expected to lead to massive reduc tions in labour cost amounting to £2m annually after year 1. More efficient operating conditions and improved quality will lead to stock reductions of £2.5m, while annual overheads will rise by £Im.
Sales are likely to be enhanced because of the firm's increased responsiveness to changes in demand and meeting specific customer requirements. Details of this and material costs are specified below.
|
Years
|
1
|
2
|
3
|
4
|
5
|
6
|
|
Additional sales (£m)
|
1.0
|
3.0
|
5.0
|
7.0
|
9.0
|
11.0
|
|
Additional material costs (£m)
|
0.5
|
1.5
|
2.5
|
3.5
|
4.5
|
5.5
|
A consultancy firm had been employed to advise on the tech nology and its correct implementation. The fees for this work are still outstanding and amount to £25,000.
Bisket pk pays Corporation Tax at 30%, which is paid approxi mately one year after the year in which the tax liability arises. Capital allowances at 25% reducing balance are available on the £6m investment, which is expected to have a 6 year life and have a residual value of £1.5m.
All figures are stated in current pounds unadjusted for expected inflation. Labour inflation is expected to be 8% p.a. while the price of other goods and services consumed by the company is expected to rise at 4% p.a. over the 6 year period. The company's monetary cost of capital is 15%, while average general inflation is expected to be 6% p.a. over the period. The current require ment for projects is for them to provide a positive net present value.
You are required to advise the management of Bisket pk whether this opportunity should be adopted, stating any assumptions made.