QUESTION ONE Dunli plc is a large multi-divisional corporation that operates in several locations across the globe. In the past five years, the company has been enjoying unprecedented success in the consumer technology sector. Business commentators have attributed the company's success to its organisational culture in which tolerance for failure is almost non-existent. The board of directors are known to swiftly remove any manager who has not reached the required level of performance. Frauke is a divisional manager in Dunli plc who now believes that her position is under threat due to narrowly missing the target set for her division in the previous year. She has been working with her management team to identify possible ways to make things better. Following a series of lengthy discussions, Frauke and her team have narrowed down their choices to investing in one of the following projects. The details and estimates available for these projects are provided below. Project A: This proposal involves the installation of a machine-intensive manufacturing facility at the company's current site in the UK. The project will last for 4 years. An initial investment of 820,000 will be required. At the end of the project's life, cash proceeds from the disposal of the equipment are estimated at 15% of this initial cost. Revenues from sales in Year 1 are estimated at 310,000 and are projected to steadily increase by 5% per year. Estimated annual operating costs are as below: Project B: Years 1-2 Years 3-4 40,000 60,000 This proposal involves setting up a labour-intensive manufacturing facility in an overseas location where labour costs are low. A small developing country in Africa has been identified for this purpose. Its current government has recently introduced a number of incentives to attract foreign investors and create jobs for the people. The country, however, has witnessed a series of civil unrest due to prolonged conflicts among its major political factions over the past decade. Several international non-governmental organizations (NGOs) have also expressed concerns over the country's weak policies regarding human rights and the environment. Project B (project length: 6 years) requires an investment of 1,500,000. It yields a net present value (NPV) of 9,687, a Payback Period (PP) of 3.2 years and an Accounting Rate of Return (ARR) of 28.3%. CONTINUED Additional information: All cash flows except for the initial investment are assumed to occur at the end of a year. The company pays tax at 35%. Tax is paid and/or received one year in arrears. The capital investment under each project would qualify for writing-down allowances (i.e., tax depreciation) at the rate of 25% per annum on a reducing balance basis. For financial reporting purposes, however, the company adopts the straight-line basis of depreciation for all of its assets. The company's cost of capital is 12%. Dunli plc's board requires all divisional managers to achieve a target accounting rate of return (ARR) of 25%. The company defines ARR as the average profit before tax divided by the average investment. Required: (a) Calculate the NPV, Payback Period and ARR (as defined by the company) for Proposal A. In addition, calculate the Profitability Index (PI) for both projects. Show your workings clearly and state any assumption that you have made in your calculation. For NPV, state your answer to the nearest pound. (35 Marks) (b) Advise Frauke on which proposal she should select. Explain and justify your recommendation by highlighting the financial and non-financial considerations that she should be aware of, including a brief critical discussion of the benefits and caveats of the used capital budgeting techniques. (15 Marks) [TOTAL: 50 MARKS] END OF QUESTION ONE