A company has decided to increase its production capacity to meet an anticipated increase in demand for its products. The extent of this increase in capacity has still to be determined and a management meeting has been called to decide which of the following two mutually exclusive proposals One and Two - should be undertaken.

Notes

(i) The investment life is ten years.

(ii) An exceptional amount of expenditure on sales promotion of 15,000 will require to be spent in Year 2 on Proposal Two. This has not been taken into account in calculating pre-depreciation profits.

(iii) It is not the intention to dispose of the buildings in ten years time; however, it is company policy to take a nominal figure into account for project evaluation purposes.

1. Evaluate the profitability (ignoring taxation and investment grants) of each of the proposals and

2. On the assumption of a cost of capital of 8% advise management of the matters to be taken into consideration when deciding between Proposal One and Proposal Two.

CapitalExpenditureBuildingsPlant&MachineryInstallationWorkingCapitalNetIncomeAnnualpre-depreciationprofits(Note(i))OtherRelevantIncome/ExpenditureSalesPromotion(Note(ii))Plant&MachineryScrapValueOne50,000200,00010,00050,00070,00010,000Two100,000300,00015,00065,00095,00015,00015,00060,000