QZ plc is a major oil company with petrol refining divisions. There is capital available and the Managing Director of the Petrol Division has been given freedom to choose between the Blue and the Red plant. Each plant has the same capacity and an expected four year life but they differ in their capital and maintenance costs. Assets are valued at NBV at the start of the year and depreciation is charged on a straight line basis.

The Divisional Finance Director has evaluated each plant using a discounted cash flow approach as follows:

	Blue million	Red million
Initial investment	26.1	20.3
Net Cash Flow 2021	9.8	10.2
Net Cash Flow 2022	9.8	8.7
Net Cash Flow 2023	9.8	5.9
Net Cash Flow 2024	9.8	3.9
Net Present Value at 16%	1.32	0.89

The General Manager is expected to earn a return on investment of 16%. The Petrol Division is currently achieving a ROI of 16.2%. If this target is not achieved in the future then the manager will not receive her performance bonus and this in turn will affect her pension when she retires in January 2023.

You are required to:

1. Explain, including supporting calculations for the life of both plants, whether you think either the return on investment or residual income will motivate the General Manager to favour the plant with the highest NPV.

(17 marks)

2. Evaluate the reasons organisations choose to divisionalise and discuss problems that might be encountered as a result of doing so.