EH Logistics is a package handling company that provides service to an e-commerce company MS Incorporated which is just like Amazon. EH Logistics is a fairly new company in the market. Currently EH Logistics has employed labour to handle packages that have to be sent to the customers of MS Incorporated. However, recently there is a sudden increase in the demand for the products sold by MS Incorporated. Hence there is increased demand for package handling. In view of this development, and recognizing the limitations of manual package handling, the managers of EH Logistics are thinking of automating the package handling process by purchasing some state- of-the-art machines. The advantage of using machines is that it would significantly reduce the handling time required per package, thereby potentially allowing the company to take on more orders at a time. However, there would be significant capital expenditure to acquire the machines, which would significantly increase the cost of capital. The time line for this investment decision is 15 years. Although the process is less efficient, EH Logistics could use its current labour force to meet the increased demand. Step 1: The Chief Financial Officer must decide whether to go with the labour intensive option or the capital intensive option (details of these projects are outlined on the following page). She has requested that your team should calculate the Net-Present-Value (NPV) and provide a recommendation as to which option to take. In your team, prepare a clear recommendation that includes the following details: a) A rationale for why or why not the incremental approach to calculate the NPV is appropriate for this kind of decision. b) The NPV and internal rate of return for the proposed labour intensive project (include calculations). c) The NPV of the proposed capital intensive project (include calculations). Page 2 of 7 d) Clearly indicate of which project you would recommend and why you are recommending this one over the other. Labour Intensive Option Capital Intensive Option If EH Logistics sticks to labour to handle packages then: If EH Logistics adopts the automation technology to handle packages then: . It has to invest in two instalments -$1,900,000 in the current year and $1,400,000 in year 1. It can pack 600,000 units in year 1 and this number will likely to go up by 120% in year 2, 10% in year 3 and 3.31% in year 4 compared to the previous years. It is expected to remain constant after that. Unlike the labour technology, production will start from year 2. The packages are priced at $2 per package. The company has invested $900,000 in buildings in the current year. The buildings will be used for handling the packages. The buildings are fully furnished and have good facilities for people to work comfortably. With the automation process EH Logistics can pack 700,000 units in year 2 and this number will likely to go up by 107% in year 3, and then 10% each year in years 4-6, compared to the previous year. The number then will go up by 3.5% compared to year 6 for in year 7 and then it will remain constant. EH Logistics estimated that the fixed cost for this arrangement is going to be $260,000 in the first year, which includes set-up cost of $50,000. The price per unit package is $2. Thereafter, the fixed cost would be $210,000. The change in net working capital in year 2 is $160,000. The variable cost per package is $1.40. For the following 4 years the change in net working capital is $11,000, $17,000, $20,000, $24,000. The buildings are fully depreciated in 15 years (at an annual rate of $60,000) for tax purposes. However, the salvage value of the buildings is $285,000. From year 7 to 15 the change in net working capital remains constant at $30,000. There will be a further increase in net working capital of $140,000, $14,000, $15000, $17000 and $20,000 for year 1, 2, 3, 4 and year 5 to year 15. To run and maintain the automation process EH Logistics has to incur fixed cost of $210,000 in year 2 and $110,000 for the life of the project. The tax rate is 30% The variable cost per package is $1.15. The machines can be depreciated $167,000 per year for tax purposes. The opportunity cost of capital for this project is 10%. There is no recovery of working capital. EH Logistics can salvage $938,000 by selling the machines at the end of their useful lives. . Since this is a big investment, EH Logistics has to source fund from different sources. So the opportunity cost of capital for this project is 14% in year 1 and 2, 11% in year 3 and then 9% for the rest of the years. The tax rate is 30%