Garnett plc. has seen sales in one of its product lines decline over the last two years. The production is currently subcontracted and any changes require a six month notice, so the management of Garnett has to decide now what to do for their most important advertising and sales period, which starts in September every year. The two identified options are:
Option A - Invest £4million to make small changes to the product design and manufacturing process, which will generate increased cash flows in the short term;
Option B - completely redesign the product and production process, which will have a longer lasting effect on cash flows, but will require an investment of £15million.
Garnett's required rate of return on investments is 10.25% and the estimated cash flows for the two options are as follows (in '000s):
|
Year
|
Option A
|
Option B
|
|
1
|
2,600
|
1,000
|
|
2
|
3,500
|
3,400
|
|
3
|
4,300
|
6,000
|
|
4
|
1,600
|
6,000
|
|
5
|
|
6,000
|
|
6
|
|
6,000
|
|
7
|
|
4,600
|
|
8
|
|
4,000
|
|
9
|
|
3,600
|
|
10
|
|
2,400
|
Required:
a) Discuss and compare the different types of investment appraisal methods Garnett can use, including a discussion of the advantages and disadvantages of each.
b) If Garnett had a rule that all investment projects need to payback within 3 years, what project would be chosen? Comment.
c) Make a recommendation as to which project should be undertaken.
d) If Garnett believes there is an opportunity to start exporting its product line to another country once sales are finished in its home country (i.e. from year 5), and it thinks it will be able to generate cash flows of £660,000 in the first year, £1,540,000 in the second and £2,300,000 in the subsequent four years, would your answer to part c) change? How?