You are considering two mutually exclusive projects for investment.

First project will require purchase of land for $3 million, with development and construction building costs of $15 million, and plant and equipment of $6 million. You will also need to spend on working capital each year. The change in net working capital is estimated to be 3% of sales every year during the life of the project (the exception being the last year of the project which reverses the sum of all previous cash flows due to working capital). Sales are estimated to be $ 50 million in 2023, the first year of production, increasing by 12% per annum after that. The cost of goods sold is 65% of sales. Fixed costs will be $10 million in 2023, increasing by 5% per year. Both buildings and plant/equipment will be depreciated straight line to zero over the 10-year project life. The buildings will have a salvage value of 20% of cost and the plant and equipment will have no salvage value. At the end of the project, you will rehabilitate the site and sell the land for light industrial development for $16 million. Relevant company tax rate for the project is 20%.

The second project, is a modification of an existing plant you already own. The plant has been idle for a number of years, but with renovation would be well suited to furfuryl alcohol production. If not used for the proposed project, you will lease out the existing plant for $70,000 per year. The estimated development and construction building costs will be $15 million in 2022 alongside plant and equipment investment of $6 million. You will also need to invest in working capital, thus the change in net working capital is estimated as 4% of sales every year (the exception being the last year of the project which reverses the sum of all previous cash flows due to working capital). Sales will be $46 million in 2023, increasing by 6% per annum thereafter. The cost of goods sold will be 75% of sales. Fixed costs will be $5 million in 2023, increasing by 4.5% per year. Both buildings and plant/equipment will be depreciated straight line to zero over the 10-year project life. The buildings will have a salvage value of 30% of cost and the plant and equipment will have no salvage value. At the end of the project, the Plant will remain idle awaiting potential future developments at no cost. The company tax rate relevant for the project is 30%.

Task

Provide project evaluations using ARR, Payback period, IRR and NPV criteria. Which project you propose company invest in and a justification for your selection of the project and the choice of method used in your project selection. Are there any other factors you would consider in your evaluation?

Provide working out for the calculations of the ARR, Payback period, IRR and NPV showing where these numbers come from. e.g. Purchase of Land ($3 million).

The Required Rate of Return for both projects is 17%.