QUESTION ONE (25 Marks)

Jimny Limited is an American 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 A:

Production at the existing factory could be expanded. The cost of the new plant for this option would be an initial outlay of $10 million. This would result in an additional $240 000 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 9% of additional profit per annum. Furthermore, additional expenses attributed to the expansion of the existing factory is R25 750. All of these expenses were included in the profit calculation.

Project B:

Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be an initial outlay of R8 000 000. In addition, equipment must be purchased and installed for the safety of workers according to the laws and regulations set by the South African government. The cost of this equipment is R600 000 and cost of installation is R150 000. Annual sales for the 10-year period is expected to be R42 000 000 annually, and fixed and variable cost of R12 000 000 and R1 000 000 respectively. Consultants fees are expected to be R125 750. Additional information: * The South African inflation is expected to exceed the American inflation by 2% throughout the life of the project. * Jimny's cost of capital is currently 12%. * The current spot exchange rate is R18.27/$. Required:

1.1

Make all the necessary calculations for the two options. (22 Marks)

1.2

Advise Jimny Limited on which of these two projects would be more profitable (3 Marks)