Question 3. Microcomputers Systems plc is considering expanding its production plant in order to exploit a patent on a new disc security device and is planning to select one of two possible manufacturing options. Option 1 involves heavier investment than option 2, leading to a more rapid build-up of sales. For option 2 no sales are made until year 2, however there are operating costs in year 1. Manufacturing option 1 Initial investment 8m YEAR: 1 Em Sales 1.0 Operating costs 2.4 1 2 Em 8.0 5.3 3 Em 12.0 5.6 4 Em 15.5 6.3 5 fm 8.0 5.5 5.5 Manufacturing option 2 Initial investment 6m YEAR: 1 2 3 4 5 Em m Em m m Sales Nil 6.0 10.0 12.0 10.0 Operating costs 2.0 4.8 5.3 4.5 Whichever manufacturing option it selects, Microcomputer Systems plc expects that the project life will be 5 years. The capital investment is to be made and paid for at the beginning of the first year. The assets purchased with the initial investment can be sold at the end of the fifth year for 10% of the initial investment. Operating cash flows are assumed to occur at the end of the year concerned. The company expects the investment to have a similar risk to the rest of the business. The current after tax weighted average cost of capital for Microcomputers Systems plc is 16p.a. Writing down allowances are allowed on the cost of plant and machinery at the rate of 25% on a reducing balance basis. Tax on profits is paid one year in arrears Corporate tax rate is 20% Question continues overleaf REQUIRED: (a) For each option determine the annual capital allowances. (8 marks) (b) For each option determine the annual corporate tax cash flows. (8 marks) (c) For each option calculate the net present value. (12 marks) (d) Comment on whether Microcomputer Systems plc should invest to take advantage of the patent, and if so which manufacturing option it should select (5 marks) (Total 33 marks) W