Ice plc has decided to expand sales in Northland because of increasing pressure in its domestic market. It is evaluating two alternative expansion proposals.

Proposal 1 Ice plc could increase production from an existing UK site. This would require initial investment of £750 000 and give export sales worth £280 000 per year before tax.

Proposal 2 Ice plc could build a factory in Northland at a cost of N$2.7m. Annual sales from the factory would initially be N$1m before tax, but these are expected to increase each year. The rate of increase each year will depend on economic conditions in Northland, as follows.

Further information Ice plc pays UK profit tax one year in arrears at a rate of 30 per cent per year. For investment appraisal purposes the company uses a seven-year planning period and ignores terminal values. Its weighted-average cost of capital is 12 per cent after tax.
Any foreign company investing in Northland pays profit tax to the Northland government one year in arrears at a rate of 30 per cent per year.

(a) Using the information provided, calculate which proposal should be adopted, explaining any assumptions that you make.

(b) Critically discuss the evaluation process used in part

(a) and suggest what further information could assist Ice plc in evaluating the two investment proposals.

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Economic conditions in Northland Good Moderate Poor Probability of these conditions occurring 25% 60% 15% Annual increase in sales 6% 5% 4% Forecast exchange rates Year 0 1 2 3 4 5 6 7 8 N$/ 3.60 3.74 3.89 4.05 4.21 4.34 4.55 4.74 4.92