The Finance Director of D&D Limited in Hong Kong is currently reviewing three investment projects which have been proposed by the divisional managers. If the company decides to go ahead with these proposals, they need to proceed immediately as the projects cannot be delayed. Last year, D&D Limited have borrowed a bank loan (repayable in 2025) to fund the expansion of its factory. After the expansion, the investment fund available for this current year is limited to HK$800,000. Details of the three proposed projects are given below. Project 1 An investment of HK$320,000 in improving the system used in assessing the health and safety conditions in workplace. The improvement on such system is expected to generate savings in labour costs from reduced staff absences due to work-related illness. Expected savings in labour costs per annum are shown as below: Year 1 2 3 4 5 Savings (HK$) 100,000 120,000 90,000 100,000 95,000 Project 2 An investment of HK$400,000 to upgrade the online customer ordering system. The upgrade aims to increase customer satisfaction and reduce the number of staff required in the Sales Team to handle sales orders. The cost savings are expected to be HK$120,000 per annum for the next five years once the system is upgraded. The Net Present Value (NPV) of this project is estimated to be HK$32,600. Project 3 An investment in upgrading the quality control equipment at a cost of HK$400,000. The equipment can help reduce the number of quality controllers required in the factory and the amount of waste as a result of using more effective equipment. This project is expected to run for five years and generate a NPV of HK$52,320. D&D Limited has a cost of capital of 12%. You can ignore the impact of taxation on the three projects under review. Required: a) In order to maximise the financial returns from the investment, advise D&D Limited which project(s) the company should invest under each of the following situations: (i) On the assumption that each of the three projects is divisible; (ii) On the assumption that none of the projects are divisible. Your answers should show which projects to invest in and the total NPV under each of the situations stated in (i) and (ii). Workings must be clearly shown. Note: you are required to calculate the NPV for Project 1. The NPV for Projects 2 and 3 are provided by the question. b) Discuss the reasons why D&D Limited may be facing capital rationing in the current year and what impact this may have on its investment decisions, such as the current investment situation facing the company. (6 marks) c) The Financial Director is particularly interested in Project 1 as it aims to reduce staff absences and the related costs. The Director has asked you, the Finance Manager of D&D Limited, to further appraise Project 1 by calculate the following (you are required to clearly state the workings and assumptions made): (i) The payback period. (ii) The Accounting Rate of Return (ARR)- you can assume that the investment of HK$320,000 is depreciated on a straight-line basis over the 5 years of the project and that the investment is worth nothing at the end of the project, i.e. depreciation of HK$64,000 per year is charged. (iii) The Internal Rate of Return (IRR). (iv)Based on your findings from c (i iii) for payback, ARR and IRR and the NPV for Project 1 identified in (a) above, make a recommendation to the Financial Director whether D&D Limited should undertake Project 1. In this Section, you can appraise Project 1 in isolation (i.e. ignoring Projects 2 and 3). You are reminded that the Company has set targets for payback period (no longer than 3 years) and ARR (20%) when appraising investment projects. (v) Explain why the four appraisal methods - payback, ARR and IRR and NPV sometimes give inconsistent results as to whether a project should be accepted. Suggest to the Financial Director which appraisal method(s) should be used when making the ultimate decision on whether Project 1 should be undertaken. Use the answers for c (i - iv) above to illustrate your explanations and suggestions. (10 marks) The Finance Director of D&D Limited in Hong Kong is currently reviewing three investment projects which have been proposed by the divisional managers. If the company decides to go ahead with these proposals, they need to proceed immediately as the projects cannot be delayed. Last year, D&D Limited have borrowed a bank loan (repayable in 2025) to fund the expansion of its factory. After the expansion, the investment fund available for this current year is limited to HK$800,000. Details of the three proposed projects are given below. Project 1 An investment of HK$320,000 in improving the system used in assessing the health and safety conditions in workplace. The improvement on such system is expected to generate savings in labour costs from reduced staff absences due to work-related illness. Expected savings in labour costs per annum are shown as below: Year 1 2 3 4 5 Savings (HK$) 100,000 120,000 90,000 100,000 95,000 Project 2 An investment of HK$400,000 to upgrade the online customer ordering system. The upgrade aims to increase customer satisfaction and reduce the number of staff required in the Sales Team to handle sales orders. The cost savings are expected to be HK$120,000 per annum for the next five years once the system is upgraded. The Net Present Value (NPV) of this project is estimated to be HK$32,600. Project 3 An investment in upgrading the quality control equipment at a cost of HK$400,000. The equipment can help reduce the number of quality controllers required in the factory and the amount of waste as a result of using more effective equipment. This project is expected to run for five years and generate a NPV of HK$52,320. D&D Limited has a cost of capital of 12%. You can ignore the impact of taxation on the three projects under review. Required: a) In order to maximise the financial returns from the investment, advise D&D Limited which project(s) the company should invest under each of the following situations: (i) On the assumption that each of the three projects is divisible; (ii) On the assumption that none of the projects are divisible. Your answers should show which projects to invest in and the total NPV under each of the situations stated in (i) and (ii). Workings must be clearly shown. Note: you are required to calculate the NPV for Project 1. The NPV for Projects 2 and 3 are provided by the question. b) Discuss the reasons why D&D Limited may be facing capital rationing in the current year and what impact this may have on its investment decisions, such as the current investment situation facing the company. (6 marks) c) The Financial Director is particularly interested in Project 1 as it aims to reduce staff absences and the related costs. The Director has asked you, the Finance Manager of D&D Limited, to further appraise Project 1 by calculate the following (you are required to clearly state the workings and assumptions made): (i) The payback period. (ii) The Accounting Rate of Return (ARR)- you can assume that the investment of HK$320,000 is depreciated on a straight-line basis over the 5 years of the project and that the investment is worth nothing at the end of the project, i.e. depreciation of HK$64,000 per year is charged. (iii) The Internal Rate of Return (IRR). (iv)Based on your findings from c (i iii) for payback, ARR and IRR and the NPV for Project 1 identified in (a) above, make a recommendation to the Financial Director whether D&D Limited should undertake Project 1. In this Section, you can appraise Project 1 in isolation (i.e. ignoring Projects 2 and 3). You are reminded that the Company has set targets for payback period (no longer than 3 years) and ARR (20%) when appraising investment projects. (v) Explain why the four appraisal methods - payback, ARR and IRR and NPV sometimes give inconsistent results as to whether a project should be accepted. Suggest to the Financial Director which appraisal method(s) should be used when making the ultimate decision on whether Project 1 should be undertaken. Use the answers for c (i - iv) above to illustrate your explanations and suggestions. (10 marks)