The company is considering a proposal to lead the industry by manufacturing and providing a new and state-of-the-art equipment to provide services to customers. Bonnie considers that a new electric equipment, which is a product from this proposed investment project, would replace most of the existing equipment. A research break- through drawn from Bonnies years of experience gives Bonnie a two-year lead on its competitors. The project proposal is summarised in the following table:

1. Capital expenditure: $10 million for new machine and $1,600,000 for a warehouse extension. The extension has been charged to the project at 50% of the full cost since only about half of the space is needed.

2. Research and development: $1,000,000 spent in 2021.

3. Working capital: initial investment in inventories.

4. Revenue: These figures assume sales of 2,000 equipment in 2023 and 3,000 per year from 2024 to 2026 at a price of $10,000 per unit.

5. Operating costs: These include all direct and indirect costs. Indirect costs (heat, light, power, fringe benefit, etc.) are assumed to be 100% of direct labour costs. Operating costs are forecasted to be $4,000 per unit.

6. Overhead: Allocated marketing and administrative costs, assumed to equal 10% of revenue.

7. Depreciation: Straight-line for 4 years.

8. Interest: Charged on capital expenditure and working capital at its current

   borrowing rate of 15%.

9. Income: Revenue less the sum of research and development, operating costs, overhead, depreciation, and interest.

10. Tax: 30% of income. Loss can be carried forward and deducted from taxable income in the future.

11. Net cash flow: Assumed equal to income less tax.

12. Net present value: Net cash flows are discounted at the companys cost of capital of 20%

Question

Assume Bonnie and the executive team has another new electric equipment which can be used to replace the existing equipment. However, this other machine has a life time of 6 years and hence, a relatively longer period of future cashflows than the project mentioned above. Which project will be more sensitive to changes in the required return? How would you analyse which project will be better in this case?

\begin{tabular}{|l|c|c|c|} \hline & 2022 & 2023 & 20242026 \\ \hline 1. Capital expenditure & 11,600 & & \\ \hline 2. Research and development & 1000 & & \\ \hline 3. Working capital & 400 & & \\ \hline 4. Revenue & & 20,000 & 30,000 \\ \hline 5. Operating costs & & 8,000 & 12,000 \\ \hline 6. Overhead & & 2,000 & 3,000 \\ \hline 7. Depreciation & & 2,900 & 2,900 \\ \hline 8. Interest & & 1,800 & 1,800 \\ \hline 9. Income & 1,000 & 5,300 & 10,300 \\ \hline 10. Tax & 0 & 1,290 & 3,090 \\ \hline 11. Net cash flows & 13,000 & 4,010 & 7,210 \\ \hline 12. Net present value =2,998 & & & \\ \hline \end{tabular}