Hirwaun Pig Iron Co. operate a single blast furnace producing pig iron. The present blast furnace is obsolete and the company is considering its replacement.

The alternatives the company is considering are:

(i) Blast furnace type Exco. Cost £2 million.

This furnace is of a standard size capable of a monthly output of 10,000 tonnes. The company expects to sell 80 per cent of its output annually at £150 per tonne on a fixed price contract. The remaining output will be sold on the open market at the following expected prices:

Required:

(a) The forecast budgets for each of the years 19X8-19X1 and for each of the blast furnaces being considered. Show the expected yearly net cash flows.
(b Appropriate computations using the net present value method for each of the blast furnaces, Exco and Ohio, for the first four years. .

(c) A report providing a recommendation to the management of Hirwaun Pig Iron Co as to which blast furnace should be purchased. Your report should include a critical evaluation of the method used to assess the capital project.

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19X8 19X9 19X0 19X1 Price per tonne 150 140 140 160 (ii) Blast furnace type Ohio. Cost 3.5 million. This large furnace is capable of a monthly output of 20,000 tonnes. A single buyer has agreed to buy all the monthly output at a fixed price which is applicable from 1 January each year. The prices fixed for the next four years are as follows: Payments per tonne of output 19X8 Price per tonne 130 19X9 130 19X0 140 19X1 170 Additional information: 1 Blast furnaces operate continuously and the operating labour is regarded as a fixed cost. During the next four years the operating labour costs will be as follows: Exco 1.2 million per annum Ohio 2.5 million per annum 2 Other forecast operating payments (excluding labour) per tonne: Exco Ohio 19X8 19X9 19X0 19X1 130 130 135 135 120 120 125 125