QUESTION $2(25$ Marks$)$

Cherry Limited is an American based manufacturer providing the latest home and office security electronic devices. The

company is currently investigating two projects for expansion. It can only undertake one of these projects and has asked

your advice in deciding which one to proceed with.

Option A

Production at the existing factory could be increased. The cost of the new machinery for this option would be an initial

outlay of $$60000000.$ This would result in an additional $$2500000$ profit being earned in each of the $10$ years that the

project would last. The plant will be fully depreciated over the $10$ years, on a straight$-$line basis and existing overheads

amounts to $$240000$ per annum. These expenses were included in the profit calculations.

Option B

Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would

be an initial cash outlay of R$24000000.$ This would result in annual sales of R$7800000.$ Annual fixed and variable

costs are R$1500000$ and R$3800000$ respectively. The fixed costs do not include depreciation expenses. Consultants$$

fees amount to R$550000.$

Additional information:

$$ Cherry Limited$$s cost of capital is currently at $8\%.$

The South African inflation is expected to exceed the American inflation by $1\%$ throughout the life of these

projects.

$$ The current exchange rate is R$19$ to the dollar.

Required:

$2\mathrm{.}1$ Advise Cherry Limited which project they should undertake, showing your calculations and assumptions to support

your advice.