Wlewvers $Co$ is engaged in the manuiacture of carpets and is considering an expansion of production facilities to

neet an anticipated increase in demand over the next flve years. The board of directors is currently considering two

mutually exclusive options.

The first option is to acquire an additional loom.

$($i$)$ The loom will have an Intlal cost of $$800,000$ and will have a life of flve years. At the end of year flve it will

have a zero scrap value.

$($il$)$ The loom will produce an additional $1,000$ carpets per annum for the next flve years.

$($iii$)$ The sales price of each carpet is $$1,000$ which has been fixed for the next five years by Government price

control.

$($iv$)$ Each carpet produced by this loom requires:

$(1)$ Material costing $$400.$

This will remain constant for the next flve years.

$(2)$ Direct labour of $10$ hours at $$10$ per hour in year one.

For each of the subsequent four years, pay will increase by $2\%$ of the preceding year's level.

$(3)$ Machine time of $20$ hours at $$10$ per hour.

This will remain constant for the next five years.

$($v$)$ Depreclation is on a straight line basis.

The second option is to subcontract production of an additional $1,000$ carpets per annum under a fixed contract for

the next five years.

$($i$)$ There is an annual subcontract fee payable at the end of each of the next five years commencing at the end

of year one at $$150,000.$ For each of the subsequent four years this fee will increase by $5\%$ of the preceding

year's level.

$($ii$)$ Over the next five years the subcontractor has agreed to produce and dellver up to a maximum $1,000$

carpets each year to the company for an agreed cost per carpet of $$700($in addition to the annual fee in $($i$)).$

$($iii$)$ The sales price of each carpet is $$1,000$ whlch has been flxed for the next five years by Government price

control.

$($iv$)$ Under the contract Weavers Co must agree to accept a minimum of $750$ carpets per annum.

$($v$)$ Weavers Co has already spent $$100,000$ conducting research into the viability of this subcontract

arrangement.

The cost of capital is $10\%.$

Ignore taxation.

Required

$($a$)$ Calculate the net present value of each of the options to the nearest $${?}^{\text{'}}000.$

State clearly any assumptions madi.

$($b$)($i$)$ On the basis of the calculation made in $($a$)$ above, which of the two options would you choose and

why?

$($ii$)$ Briefly outline FOUR key factors which should be considered before a final decision is reached.

$($c$)($i$)$ Explain why it is important to evaluate carefully capital investment decisions.

$(4$ marks$)$