BB Limited is an American based manufacturer of heavy-duty equipment. The company is currently investigating two projects for expansion. It can only undertake one of them and has asked your advice in deciding which one to proceed with. Project 1: Production at the existing factory could be expanded. The cost of the new plant for this option would be an initial outlay of $31 050 000. This would result in an additional $854 000 profit being earned in each of the 5 years that the project would last. The new plant to be fully depreciated over the 5 years, on a straight-line basis, in accordance with the company's accounting policy. The financial team has also determined that the new plant must bear its share of the existing overheads and that amounted to $11 750 per month over the 5 years. Both the depreciation and existing overhead expense were also included in the profit calculation. Project 2: Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be an initial outlay of R300 400 000. Monthly sales for the 5-year period is expected to be R22 000 000 per month, and fixed and variable cost of R9 000 000 and R4 000 000 per month respectively. Consultants fees is expected to be R1 000 500. Additional information: * The South African inflation is expected to exceed the American inflation by 3% throughout the life of the project. * BB Limited cost of capital is currently 11%. * The current spot exchange rate is R20.25/$.
BB Limited is an American based manufacturer of heavy-duty equipment. The company is currently investigating two projects for expansion. It can only undertake one of them and has asked your advice in deciding which one to proceed with. Project 1: Production at the existing factory could be expanded. The cost of the new plant for this option would be an initial outlay of $31 050 000. This would result in an additional $854 000 profit being earned in each of the 5 years that the project would last. The new plant to be fully depreciated over the 5 years, on a straight-line basis, in accordance with the company's accounting policy. The financial team has also determined that the new plant must bear its share of the existing overheads and that amounted to $11 750 per month over the 5 years. Both the depreciation and existing overhead expense were also included in the profit calculation. Project 2: Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be an initial outlay of R300 400 000. Monthly sales for the 5-year period is expected to be R22 000 000 per month, and fixed and variable cost of R9 000 000 and R4 000 000 per month respectively. Consultants fees is expected to be R1 000 500. Additional information: * The South African inflation is expected to exceed the American inflation by 3% throughout the life of the project. * BB Limited cost of capital is currently 11%. * The current spot exchange rate is R20.25/$.
Chapter9: Capital Budgeting And Cash Flow Analysis
Section: Chapter Questions
Problem 8P
Related questions
Question
Advise BB Limited which project they should undertake, showing your calculations and assumptions to
support your advice.
Use the correct discount rate, rounded to 4 decimals
Report inflows/outflows as appropriate +/-
Do not forget to convert the currency so comparison can be done
Detailed assessment and recommendation required.
Transcribed Image Text:BB Limited is an American based manufacturer of heavy-duty equipment. The company is currently investigating two
projects for expansion. It can only undertake one of them and has asked your advice in deciding which one to proceed with.
Project 1:
Production at the existing factory could be expanded. The cost of the new plant for this option would be an initial outlay of
$31 050 000. This would result in an additional $854 000 profit being earned in each of the 5 years that the project would
last. The new plant to be fully depreciated over the 5 years, on a straight-line basis, in accordance with the company's
accounting policy. The financial team has also determined that the new plant must bear its share of the existing overheads
and that amounted to $11 750 per month over the 5 years. Both the depreciation and existing overhead expense were also
included in the profit calculation.
Project 2:
Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be
an initial outlay of R300 400 000. Monthly sales for the 5-year period is expected to be R22 000 000 per month, and fixed
and variable cost of R9 000 000 and R4 000 000 per month respectively. Consultants fees is expected to be R1 000 500.
Additional information:
* The South African inflation is expected to exceed the American inflation by 3% throughout the life of the project.
* BB Limited cost of capital is currently 11%.
* The current spot exchange rate is R20.25/$.
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