Coursework 1:                     Project Evaluation

Easter Ross Engineering Plc, a manufacturer of specialist steel design products, has recently spent £1.5m in developing its manufacturing facilities and dry dock in the Moray Firth. It has already secured a contract for multiple orders 200 offshore wind farm jackets destined for the North Sea, and this contract will run initially for 5 years, based on orders pending.

Capital costs for kitting out the additional facilities will include a new ring crane at a cost of £4.0m and will occur at the start of the project.  This Proposal would not attract any element of Easter Ross Engineering annual investment allowance (total of £1m) assigned for equipment.  However, tax-allowable depreciation of 25% per annum on a reducing basis is applicable, with the residual value at the end of year 5 being considered for disposal at £1m.

The new contract will attract 10% of head office allocated overhead costs which currently run at £8m. The new contract requires an initial increase in component inventories of £3m to maintain service levels on the new orders.

First year relevant costs and revenues for production are:

£m

Revenues                                                  8.0

Labour Costs                                            3.0

Material/component costs                       2.0

Current revenue forecasts suggest prices are likely to inflate beyond year one at 3% per annum, labour costs at 2% and material costs at 1%.

The company is still monitoring the global economic impacts of the UK’s withdrawal from the European Union, the war in Ukraine and post-pandemic supply chain concerns and anticipates that it will start to experience economic impacts after three years into the use of the improved facility, as European yards improve their facilities and increase the level of competition in the renewables sector.  It is estimated that economic recession will occur with a 35% probability and a reduced economic downturn with a 65% probability. In the case of a recession, revenue will decline 10% each year and labour costs will inflate an additional 3% each year.  In the case of low economic downturn, sales will decline 5% each year and labour costs inflate an additional 1% each year. 

After 3 years, the company recognises that life in the UK post-global events may become too tough to match competition from other countries, and the Directors have factored in the opportunity to bail-out of offshore wind farm jacket manufacturing and return to their core engineering business, realising the residual value of the investment of £2m net of redundancy costs.  

The following information is also available:

• Assume cash flows occur at the end of each year except for those occurring at the start of the project and calculations for 5 years of operation should be provided.
• The company has a 12% cost of capital.
• A Corporation Tax Rate of 25% applies to Easter Ross Engineering plc. Tax is paid one year after the related operating cash flow is earned.