Marathon Auto Engineering PLC is an independent automobile producer that generates various trucks

for industrial use. The company owns and operates two automobile manufacturing plants in the UK. At

the moment, Vehicles produced at these plants have petrol or diesel engines. Marathon Auto

Engineering PLC purchases most of its engines from a country in Eastern Asia, which is known to have a

long-standing border dispute with one of its neighbours. There has been no interruption in engine

supplies from this country over the past ten years but several analysts have recently expressed concerns

that the border dispute between the supplying country and its neighbour is likely to turn into an armed

conflict in the near future.

As part of its expansion plan, Marathon Auto Engineering PLC is considering to construct a new

automobile manufacturing plant. However, there are differing views among the directors on which type

of engines this new plant would use in the trucks. Some of the directors believe that the new plant

should also use the same petrol or diesel engines as this might allow the company to negotiate a lower

price for its engine supplies. Others, however, believe that it is worthwhile to invest in a new

manufacturing plant that will produce electric engines to be used in the trucks.

You have been asked by the managing director of the company, Mr Elijah Tatason, to analyse and

produce a report based on the following information:

Option A:

Plant that produces

petrol or diesel

engines-based trucks

Option B:

Plant that produces

electric engines-

based trucks

Initial investment ( million) 14 22

Revenue ( million) in Year 1

(see additional information)

5.35 5.35

Operating Costs ( million) in Year 1

(see additional information)

2.4 1.2

Residual or salvage value ( million) 3.8 2.5

Expected life 8 years 8 years

Additional information:

1) All cash flows (other than the initial investment) can be assumed to occur at year end.

2) Revenue: Assume all figures in cash. An increase of 10% per annum is expected from Year 2

onwards. Operating Costs: Assume all figures in cash. An increase of 10% per annum is expected

from Year 2 onwards. (that is, year 2 increase will be based on year 1 figures; year 3 increase

will based on year 2 figures, and so on).

3) Marathon Auto Engineering PLC pays corporation tax at 20%. Tax is paid one year in arrears.

4) Capital investment in each project would qualify for writing-down allowances at 10% per annum

on a reducing balance basis. Balancing allowance can be claimed where applicable.

5) The company's cost of capital is estimated at 10%.

Note: Marathon Auto Engineering PLC is a fictitious company.

Q1- Your calculation of the net present value (NPV) and Internal Rate of Return (IRR) of each of the

two options.