All operating expenses are expected to remain constant

Eclipse Ltd, an Australian manufacturer of Scientific Equipment, is considering expanding its Australian operation into producing Smart Phones. The Chief Financial Officer (CFO) of the company, Shelley Shores, believes there will be significant opportunities for growth for the company in the Smart phones market and is therefore looking to construct a new manufacturing Plant in West Melbourne. Eclipse Ltd has not manufactured Smart Phones before but they have extensively researched the market and believe they can compete successfully. For this expansion Miss Shores has two options. The first option, Project A, is a highly automated process that involves significant capital outlays but has lower running costs. Project B is a more labour intensive facility that has lower initial capital outlays but higher running costs. Project A and Project B are mutually exclusive Projects. As Miss Shores’ assistant you have been asked to prepare a preliminary analysis of the Projects to enable her to make a recommendation to the Board of Directors. To assist your evaluation Miss Shores has provided you with the following information: i) Estimated Sales for Project A Smart Phones amount to 150,000 units per year, starting next year, with sales increasing in line with economic growth. Estimated sales for Project B Smart Phones amount to 104,000 units per year, starting next year, with sales increasing in line with economic growth. ii) The Project A Smart Phone has a selling price of $295 next year, increasing in line with inflation. The Project B Smart Phone has a selling price of $384 next year, increasing in line with inflation. iii) The nominal economic growth rate is Projected to be 4% per year. iv) Project A is expected to remain in operation for 6 years; then it will terminate. Project B is expected to remain in operation for 5 years; then it will terminate. In the final year of each Project the machinery will be sold for 35% of its initial value. The land and buildings will be retained by the company for future use. v) Last year, Eclipse Ltd. paid MacBank $500, 000 for a feasibility study that confirmed the manufacturing expansion was economically viable. vi) The machinery is considered depreciable for tax purposes and will be depreciated using a diminishing value method. The land, buildings and furnishings are not depreciable for tax purposes. vii) Project A will require a provision of $4,800,000 in working capital and Project B will require a provision of $3,500,000 in working capital. These requirements will remain unchanged over the life of the Projects. viii) There will be additional Sales and Marketing expenses if the Project goes ahead. Annually, Project A will incur $2,000,000 and Project B will incur $3,000,000. These annual costs will increase with inflation. ix) Head Office expenses will not increase. However, a fixed allocation of $360,000 per year will be charged to whichever Project goes ahead. x) All operating expenses are expected to remain constant. xi) Eclipse Ltd. is subject to a tax rate of 30%. Tax is paid in the same year it is incurred. [Do not make any other assumptions about the company’s tax liability.]