QUESTION 4 (25)

Hobs Limited is a Zimbabwean based manufacturer of heavy-duty equipment. The company is currently investigating two projects for expansion. It can only undertake one of them and has asked your advice in deciding which one to proceed with.

Project Alpha:

Production at the existing factory could be expanded. The cost of the new plant for this

option would be an initial outlay of ZW$50 million. This would result in an additional ZW$19 900 000 profit being earned in each of the 10 years that the project would last.

The new plant to be fully depreciated over the 10 years, on a straight-line basis, in accordance with the company's accounting policy. The financial team has also determined that the new plant must bear its share of the existing overheads and that amounted to ZW$200 000 per annum. These expenses were also included in the profit calculation. Consultant fees cost R200 000.

Project Beta:

Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be an initial outlay of R300 million. Annual sales for the 10 year period is expected to be R220 million annually, and fixed and variable cost of R70 million and R64.4 million respectively. The fixed cost includes depreciation of R30 million per annum. Consultants fees is expected to be R0.25 million.

Additional information

• The South African inflation is expected to exceed the Zimbabwean inflation by 2% throughout the life of the project.
• Hobs Limited cost of capital is currently 12%.
• The current spot exchange rate is R8/ZW$.

Required:

4.1 Make all the necessary calculations for the two options. (21)

4.2 Advise Hobs Limited if it is worth investing in neither, in one or in both of these projects

(4)