Question$-1$

Hypothetical Company Project

AUTO FORCE Ltd is an automation firm that invests much in research and development $($R&D$)$

before releasing new equipment, typically designed to save labour time. AUTO FORCE Ltd

serves the manufacturing industry through the automation of production facilities. The firm recently spent $$700,000$ developing AFP$-$N$1,$ an automatic food preparation system. However, a

few random test runs revealed that AFP$-$N$1$ is not yet market$-$ready because it has difficulty

distinguishing residue from fine output. Such irregular interruptions need a long restart time.

During the reset phase, companies that purchase and install AFP$-$N$1$ may lose a significant

amount of output. Nonetheless, given the level of rivalry, AUTO FORCE Ltd officials want to

release the AFP$-$N$1$ machine to be the market leader against other competitors. A local importer

will sell AUTO FORCE the equipment required to construct the plant that will manufacture

machine AFP$-$N$1$ for $$15,600,000.$ AUTO FORCE Ltd must pay an additional $$1,900,000$ in

installation fees while the transportation costs of $$500,000$ would be paid by the supplier of the

plant. The plant's economic life would be six years, and it would be depreciated at a straight$-$line

rate of $15\%$ on prime cost each year.

According to the marketing director at AUTO FORCE Ltd$,300$ units of the AFP$-$N$1$ machine can

be sold in the first year, with sales dropping by $25$ units each year for the remainder of the

project. The projected selling price per unit is $$125,000.$ As long as at least $200$ units are

produced and sold each year, the variable cost of production is predicted to be $60\%$ of sales

revenue. Once the production and sales drop below $200$ units, the variable cost of production

will increase to $70\%$ of sales revenue. The fixed costs of operating this factory would be

$$5,000,000$ per year. The production of AFP$-$N$1$ will most likely require an initial inventory of

$$650,000.$ Also, as sales increase, $$525,000$ will be locked up in accounts receivables, but this

will be substantially offset by a $$175,000$ increase in accounts payable. The project management

intends to maintain the same level of net working capital $($NWC$)$ throughout the project's

duration. This indicates that there will be no additional fresh investments in NWC during the

project's lifetime.

The new plant will be located in a manufacturing space that is currently utilised for storage.

Currently, this space yields a net income of $$25,000$ a month; however, it will be discontinued

due to the new plant. Additionally, when AUTO FORCE Ltd sells machine AFP$-$N$1,$ its annual

income from automation consulting fees will decrease by $$75,000.$ After the economic life of this

project, the plant would be transferred $($sold$)$ to another project for a price of $$2,200,000.$

If a firm purchases AUTO FORCE Ltd$.$s AFP$-$N$1$ machine, it will eventually replace many of its

unskilled and semi$-$skilled employees with a few skilled ones to increase production efficiency.

An Association of Labour Unions is discouraging and opposing firms installing AFP$-$N$1$ because

it will result in many people losing their employment since they will be redundant. In response

to the Association's worries, AUTO FORCE Ltd$.$s management has identified another project

that would manufacture semi$-$automatic machines SAP$-$N$5$ and will require both semi$-$skilled

and skilled people. The initial total investment for this SAP$-$N$5$ project would be $10\%$ lower than

the total initial cost of the AFP$-$N$1$ project, and the predicted future net cash flows $($after all

adjustments$)$ for this six$-$year project would be as follows: Year$-1$: $$3,250,000$; Year$-2$:

$$5,200,000$; Year$-3$: $$6,300,000$; Year$-4$: $$7,500,000$; Year$-5$: $$8,100,000$ and Year$-6$: $$4,500,000.$

The company utilises its weighted average cost of capital $($WACC$)$ to determine its required rate

of return. Recently, the WACC of the company is fluctuating between $14\%$ and $18\%.$

Management has chosen to utilise both rates in evaluating this project. The applicable tax rate

for this company is $30\%.$ The company also uses a discounted payback period benchmark of $4$

years. Before reaching a final decision in the upcoming meeting, the Chief Finance Officer $($CFO$)$

of AUTO FORCE Ltd is seeking a comprehensive explanation of the key components of the AFP$-$N$1$ project. The CFO requests a formal report that includes a thorough analysis of cash flows and

clear explanations of the results, utilising appropriate capital budgeting procedures commonly

employed for project evaluation. In addition, the CFO is interested in examining the specific

details of the comparison between the AFP$-$N$1$ and SAP$-$N$5$ projects. This analysis will involve

evaluating the results of appropriate capital budgeting methods, considering both a $14\%$ and

$18\%$ required rate, determining the crossover rate, and considering all quantitative and

qualitative factors that can contribute to making a final decision. This comparative discussion of

findings is to be presented in a separate section of the report.