Advanced: Evaluation of a proposed investment of computer integrated manufacturing equipment and a discussion of NPV and ARR Abert, the production manager of Blom pic, a manufacturer of precision tools, has recently attended a major international exhibition on Computer Integrated Manufacturing (CIM). He has read of the improvements in product quality and profitability achieved by companies which have switched to this new technology. In particular, his Japanese competitors are believed to use CIM equipment extensively. Abert is sufficiently concerned about his company’s future to commis¬ sion a report from Saint-Foix Ltd, a vendor of CIM equipment, as to the appropriateness of utilising CIM for all his manufacturing operations.

The report, which has recently been prepared, suggests that the following costs and benefits will accrue to Blom pic as a result of investing in an appropriate CIM system:

(1) Costs of implementing CIM

(i) Capital equipment costs will be £40m. The equipment will have an estimated life of 10 years, after which time its disposal value will be £10m.

(ii) Proper use of the equipment will require the substantial re-training of current employees. As a result of the necessary changes in the production process, and the time spent on retraining, Blom pic will lose production (and sales) in its first two years of implementation. The lost production (and sales) will cost the company £10m per annum.

(iii) The annual costs of writing software and maintaining the computer equipment will be £4m.

(2) Benefits of implementing CIM

(i) The use of CIM will enhance the quality of Blom pic’s products. This will lead to less reworking of products, and a conse¬ quent reduction in warranty costs. The annual cost savings are expected to be £12m per annum.

(ii) The CIM equipment will use less floor space than the existing machinery. As a result one existing factory will no longer be needed. It is estimated that the factory can be let at an annual rental of £2m.
(iii) Better planning and flow of work will result in an immediate reduction in the existing levels of working capital from £13m to £8m.
The directors of Blom pic currently require all investments to generate a positive net present value at a cost of capital of 15% and to show an accounting rate of return in the first year of at least 15%. You may assume that all cash flows arise at the end of the year, except for those relating to the equipment and re-training costs, and the reduction in working capital. It is Blom pic’s intention to capitalise re-training costs for management accounting purposes. Requirements:

(a) Determine whether Blom pic should invest in the CIM technology on the basis of its exist¬ ing investment criteria. (10 marks)

(b) Discuss possible reasons as to why Blom pic currently requires its long-term investments to meet both the net present value and the accounting rate of return criteria. (8 marks)

(c) Discuss the additional factors Blom pic should consider when deciding whether to switch to CIM technology. (7 marks)
(Total 25 marks) ICAEW P2 Financial Management