Capital Budgeting

2. All amounts are in $AUD. Blackmores is evaluating between two manufacturing facilities projects in Asia. In order to mitigate the risk and assess the fit for purpose of these manufacturing plants Blackmores asked "SGS Ltd." to conduct a technical due diligence on each of the two facilities. "SGS Ltd." is asking $1 Million as a fixed fee for its consulting services. Project A has an initial outlay of dollars $500 million and Project B has an initial outlay of $950 million. Project A will produce 350,000,000 tablets ready for sale starting at the end of year 1 until the end of year 5 and 450,000,000 tablets starting at the end of year 6 until the end of year 10. It will also incur working capital expenses at the end of year 1 to 5 of $40 million (this working capital will not be recovered). Project B will produce 600,000,000 tablets ready for sale starting at the end of year 1 until the end of year 10. It will also incur working capital expenses at the end of year 1 to 3 of $90 million (this working capital will not be recovered). Assume that the average selling price of a single tablet is $1 over the ten years. The operating costs of both projects will be 30% of the revenues from year 1-10. Both investment will be depreciated on a straight-line basis over ten years to 0 book value. Blackmores has estimated that the manufacturing plants can be sold at the end of year 10 respectively for $100 million (Project A) and $150 million (Project B).The tax rate is 30%. All cash flows are annual and are received at the end of the year. The weighted average cost of capital for both projects is 10%.

f) Suppose that Blackmores' management payback rule is 4 years. Based on your analysis which project should be chosen? Justify your answer with reference to theory. What other elements could be taken into consideration when selecting the project?