The directors of Advanced plc are currently considering an investment in new production machinery to replace existing machinery. The new machinery would produce goods more efficiently, leading to increased sales volume. The investment required will be £1,150,000 payable at the start of the project. The alternative course of action would be to continue using the existing machinery for a further five years, at the end of which time it would have to be replaced.
The following forecasts of sales and production volumes have been made:
Sales (in units)
Production (in units)
Further information
1. The new machinery will reduce production costs from their present level of £7.50 per unit to £6.20 per unit. These production costs exclude depreciation.
2. The increased sales volume will be achieved by reducing unit selling prices from their present level of £10.00 per unit to £8.50 per unit.
3. The new machinery will have a scrap value of £150,000 after five years.
4. The existing machinery will have a scrap value of £30,000 at the start of Year 1. Its scrap value will be £20,000 at the end of Year
5. The cost of capital to the company, in money terms, is presently 12% per annum.
Required:
a) Prepare a report to the directors of Advanced plc on the proposed investment decision.
b) List any further matters which the directors should consider before making their decision.