PRUDENCE Corporation is an automation company that invests heavily in research and development (R&D) before introducing any new machine, which are mostly innovative labour-saving alternatives. Manufacturing firms in the industry are customers of PRUDENCE Corporation. Recently, PRUDENCE spent $130,000 to innovate an automatic food processing machine AFP20 to reduce wastage; however, the machine AFP20 is not fully ready yet for the market due to its occasional imperfection in separating residue and fine output, as reflected in a few random trial runs. Such infrequent failures require long reset time. Firms installing AFP20 may experience significant production loss during reset time. Nonetheless, due to the pressure of severe competition, PRUDENCE managers are planning to introduce this machine AFP20 in the market before any new offer from competitors. The company is expecting that the final version of reliable machine AFP20-M would be available for production in four years time. Required machineries for building the plant to manufacture machine AFP20 can be procured from a local importer at a cost of $6,200,000. PRUDENCE Corp. has to incur additional transportation cost of $50,000 and installation costs of $250,000; whereas the local importer will pay the import duty of $500,000. The plant would have economic life of five years and will be depreciated for tax purposes using straight line rate of 20 per cent per year. At the end of this project, the plant would be transferred (i.e., sold) to another project at a price of $700,000. The Marketing manager of PRUDENCE Corp has projected that 300 units of the machine AFP20 can be sold in the first year and that sales will drop by 25 units every year during the life of the project. Expected sales price would be $50,000 per unit. Variable cost of production is estimated to be 60% of sales revenue as long annual production is at least 200 units. Fixed factory overhead of $1,800,000 per year would be allocated to this production plant. It is estimated that the project will require an initial investment in stock (inventory) of $320,000. Moreover, $140,000 will be tied up with debtors (accounts receivables) due to increasing sales; however, it would be partially offset by $60,000 increase in creditors (accounts payable). The project manager has the plan to maintain the same level of net working capital (NWC) throughout the life of the project (i.e., no further investment in NWC during the project life) before final recovery of NWC at the end of four years. There will be pre-launching expenses of $100,000 to be incurred initially for this project. New plant will occupy a portion of factory space that is currently being used for storage purposes in generating monthly net revenue of $10,000, but it will discontinue due to installation of the plant. Furthermore, selling machine AFP20 will reduce PRUDENCEs automation consultation fee income by $50,000 per year where associated cost is 40 per cent of such fee income. Firms buying machine AFP20 from PRUDENCE will ultimately replace many of their unskilled and semi-skilled workers by a few skilled workers for improving production efficiency. An Association of Labour Unions opposes the probable installation of AFP20 by the firms as many workers will be losing their jobs due to not having sufficient skill. Considering the issue raised by the Association, the managers of PRUDENCE have identified another project that will produce semi-automatic machine FP19, which will require both semi-skilled and skilled workers. Initial total investment for this FP19 project would be the same as AFP20 project and projected future cash flows (after all adjustments) for this five-year project would be as follows: Year-1: $2,100,000; Year-2: $2,600,000; Year-3: $3,500,000; Year-4: $3,300,000; Year-5: $1,400,000; The company uses required rate of return considering its weighted average cost of capital (WACC) that varies from 14 to 19 per cent in recent time. Management has decided to use both rates to evaluate this project. Corporate tax rate is 30%. PRUDENCE uses a target discounted payback period of 3.5 years. Before taking final decision in the upcoming meeting, the Chief Financial Officer (CFO) of PRUDENCE Corp requires a clear explanation of all relevant issues relating to the machine AFP20 project. The CFO also asks for a FORMAL REPORT with detail analysis of cash flows and explanations of results using appropriate capital budgeting methods that are usually used in evaluating projects. Furthermore, in a separate section in the report, the CFO is interested to review the details of the comparison between AFP20 and FP19 projects with respect to the results of appropriate capital budgeting methods using both 14 and 19 per cent required rates, crossover rate and all relevant factors that can assist in taking final decision.

Required Using Excel Spreadsheet, prepare a full analysis to be presented to the CFO of PRUDENCE Corp. in evaluating whether either project should be started or not. Your analysis should include the following: Table of cash flows (Show all digits, do not convert amounts to $ in million or thousand) Use of excel formulae where appropriate (refer eLearning video of Week-6) A formal report (1200 1500 words, excluding table of content, executive summary, tables, references and appendices) outlining your recommendation as to whether PRUDENCE Company should proceed with either project. Justify your recommendations using quantitative and qualitative issues and your analysis of probable risks and benefits relating to the project. A comparative statement using 14 per cent and 19 per cent required rate is to be presented in a separate section in the report.