James Fawn has to review two mutually exclusive capital-expenditure proposals. These projects cannot be undertaken simultaneously. As per strategic-analysis staff, 14% increase in polypropylene output makes no sense, but half that amount does. Also the different location can affect to the capital budgeting, as they cannot share the investment together. These separate projects will need a huge amount of the money in order to support their improvement process. Therefore, James Fawn can sponsor only one project for approval by the board.
Both projects belong in the engineering-efficiency category; therefore, for the proposal to be considered both projects have to meet at least 3 of 4 performance hurdles. Based on the original analysis Rotterdam is a better choice than Merseyside in the 4 criteria. However there were some pointes that were missed and the cash flow and the NPV needs to be recomputed.
There are a few problems in the Rotterdam proposal that needs to be considered in cash flow and NPV calculations before making decision: 1) 3% inflation rate was not counted; 2) Depreciation was calculated wrong. In applying the DDB approach to a 15-year project, the formula for accelerated depreciation should be used for the first 10 years, after which depreciation should be calculated on a straight-line basis; 3) WIP inventory should be added back at the end of the project; 4) should only include overheads directly related to the project. As the pipelines are initial asset investments for the project we need to add 3.5% overhead just for pipeline £3.5 million and not the book value of all assets; 5) Remove the terminal value of land as it does not let to see the actual value of the project; 6) And to consider the opportunity cost of £2.5 million (£6 – £3.5) from right –of-way if they sell it today.
The projects were advocated and presented in different ways. Merseyside is simple (3 pages) and to the point. Rotterdam proposal is long and in depth (90 pages). Also...