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 power 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.

Capital Expenditure One Two

Buildings 50,000 100,000

Plant & Machinery 200,000 300,000

Installation 10,000 15,000

Working Capital 50,000 65,000

Net Income

Annual pre-depreciation profits (Note (i)) 70,000 95,000

Other Relevant Income/Expenditure

Sales Promotion (Note (ii)) - 15,000

Plant & Machinery Scrap Value 10,000 15,000

Buildings Disposable Value (Note (iii)) 30,000 60,000

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 Ni. 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 considered when deciding between Proposal One and Proposal Two.