CAF plc is a large multinational organization that manufactures a range of highly engineered products/components for the aircraft and vehicle industries. The directors are considering the future of one of the company’s factories in the UK which manufactures product A. Product A is coming to the end of its life but another two years’ production is planned. This is expected to produce a net cash inflow of £3 million next year and £2.3 million in the product’s final year.
Product AA
CAF plc has already decided to replace product A with product AA which will be ready to go into production in two years’ time. Product AA is expected to have a life of eight years. It could be made either at the UK factory under consideration or in an eastern European factory owned by CAF plc. The UK factory is located closer to the markets and therefore, if product AA is made in eastern Europe, the company will incur extra transport costs of £10 per unit. Production costs will be the same in both countries. Product AA will require additional equipment and staff will need training; this will cost £6 million at either location. 200,000 units of product AA will be made each year and each unit will generate a net cash inflow of £25 before extra transport costs. If product AA is made in the UK, the factory will be closed and sold at the end of the product’s life.
Product X
Now, however, the directors are considering a further possibility: product X could be produced at the UK factory and product AA at the eastern European factory. Product X must be introduced in one year’s time and will remain in production for three years. If it is introduced, the manufacture of product A will have to cease a year earlier than planned. If this happened, output of product A would be increased by 12.5% to maximum capacity next year, its last year, to build stock prior to the product’s withdrawal. The existing staff would be transferred to product X. The equipment needed to make product X would cost £4 million. 50,000 units of product X would be made in its first year; after that, production would rise to 75,000 units a year. Product X would earn a net cash fl ow of £70 per unit. After three years’ production of product X, the UK factory would be closed and sold. (Product AA would not be transferred back to the factory in the UK at that stage; production would continue at the eastern European site.)
Sale of factory
It is expected that the UK factory could be sold for £5.5 million at any time between the beginning of year 2 and the end of year 10. If the factory is sold, CAF plc will make redundancy payments of £2 million and the sale of equipment will raise £350,000. CAF plc’s cost of capital is 5% each year.

Required:
a) Prepare calculations that show which of the three options is financially the best. (15 marks)
b) The directors of CAF plc are unsure whether their estimates are correct. Calculate and discuss the sensitivity of your choice of option in (a) to:
i) changes in transport costs; (3 marks)
ii) changes in the selling price of the factory. (3 marks)
c) Briefly discuss the business issues that should be considered before relocating to another country. (4 marks) (Total = 25 marks)