A company has to replace a current production process. The current process is rapidly becoming unreliable whereas demand for the product is growing. The company must choose between alternatives to replace the process. It can buy:
(a) Either a large capacity process now at a cost of £4 million, or
(b) A medium capacity process at a cost of £2.2 million and an additional medium capacity process, also at a cost of £2.2 million, to be installed after three years.
The contribution to profit per year from operating the two alternatives are:
Assume a discount rate of 20 per cent. Present a discounted cash flow analysis of this problem and decide between the alternatives.
Comment on other factors, not taken into account in your discounted cash flow analysis, which you think may be relevant to management's decision.