George decided to use 10% as the required rate of return, made up of 6% currently obtainable from risk-free government securities plus a small element to compensate for risk. He went home that evening with a very full briefcase and a number of unresolved questions:
Q1. How much of the information which he had gathered was really relevant to the decision?
Q2. What was the best approach to assessing the economic worth of the proposal? The company used discounted payback, but he felt that discounted cash flow techniques (IRR and NPV) had some merit.
Q3. Cash was particularly limited this year and acceptance of this project could mean that other projects would have to be deferred. How should this be taken into consideration?
Q4. How should the strategic factors be assessed?
Other information concerning the new project is as follows:
Delphi Cones & Tubes Plc pays Corporation Tax at 30% and annual writing-down allowances (capital allowance) of 25% on the reducing balance may be claimed. The existing machine has a nil value for tax purposes and tax is payable in the same year as the cash flows to which it relates. The impact of changes in working capital is to be ignored.
Required: Prepare the case, with recommendations, to be presented by George at tomorrow’s meeting. Your report should not be more than 2000 words and should address questions 1-4 above.
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