Calculation for NPV of Making (Continuing Indigenous Manufacturing):

a. Manufacturing Cost: 400,000 units/year × £0.90/unit = £360,000

b. Raw Materials: 400,000 units/year × £0.60/unit = £240,000

c. Salary of Operator: £25,000/year

d. Total Cost: £360,000 + £240,000 + £25,000 = £625,000 per year

e. Tax Saved on Total Cost: £625,000 × 20% (corporate tax rate) = £125,000 per year

f. Change in Inventory: Assumed to be zero since the current stockholding is not specified to change.

g. Warehouse Extension: No cash outlay is involved in the warehouse extension.

h. Tax Saved on Warehouse Depreciation: £150,000 ÷ 25 years × 20% (corporate tax rate) = £12,000
per year

i. Tax Saved on Machine Depreciation: (£150,000 - £20,000) ÷ 8 years × 25% (capital allowance rate) =
£12,500 per year

j. Total Cash Flows: Cash inflow from tax savings = £125,000 + £12,000 + £12,500 = £149,500 per year

k. NPV: Calculate NPV based on the cash flows and the required rate of return (17%).

NPV Calculation for Making:

Initial Investment = £0 (no cash outlay required)

Cash Flows over 8 years = £149,500 per year

Required Rate of Return = 17%

NPV = Σ [CFt / (1 + r)^t] – Initial Investment

Where:

CFt = Cash Flow in year t

R = Required rate of return

T = Time period

NPV = Σ [£149,500 / (1 + 0.17)^t] - £0

For t = 1: NPV = £149,500 / (1 + 0.17)^1 = £127,564.96

For t = 2: NPV = £149,500 / (1 + 0.17)^2 = £109,019.07

...

For t = 8: NPV = £149,500 / (1 + 0.17)^8 = £54,127.26

Summing up all the NPVs for each year:

NPV = £127,564.96 + £109,019.07 + ... + £54,127.26 = £528,558.18

Calculation for NPV of Buying (Accepting Smart Engineers’ Offer):

I. Purchasing Cost: 400,000 units/year × £1.45/unit = £580,000 per year

m. Opportunity Cost of Operator: £5,000 (difference in annual salaries for the operator in other
department)

n. Total Cost: £580,000 + £5,000 = £585,000 per year

o. Tax Saved on Total Cost: £585,000 × 20% (corporate tax rate) = £117,000 per year

p. Change in Inventory: 50,000 units/batch – 2 weeks’ supplies (assumed to be 10,000 units) = 40,000
units

Change in inventory per year = 40,000 units × 8 batches/year = 320,000 units

q. Warehouse Extension: £150,000 (Depreciation over 25 years)

r. Tax Saved on Warehouse Depreciation: £150,000 ÷ 25 years × 20% (corporate tax rate) = £12,000
per year

s. Sale of Old Machine: £120,000 (book value) - £20,000 (market value) = £100,000 (book loss)

t. Tax Saved on Sale of Machine: £100,000 × 20% (corporate tax rate) = £20,000 (tax shield from loss)

u. Cost of Suppl. Machine: £20,000

v. Tax Saved on Suppl. Machine: £20,000 × 25% (capital allowance rate) = £5,000 per year

w. Total Cash Flows: Cash inflow from tax savings = £117,000 + £12,000 + £20,000 + £5,000 =
£154,000 per year

x. NPV: Calculate NPV based on the cash flows and the required rate of return (17%).

NPV Calculation for Buying:

Initial Investment = £20,000 (Cost of purchasing the supplemental machine)

Cash Flows over 8 years = £154,000 per year

Required Rate of Return = 17%

NPV = Σ [CFt / (1 + r)^t] – Initial Investment

Where:

CFt = Cash Flow in year t

R = Required rate of return

T = Time period

NPV = Σ [£154,000 / (1 + 0.17)^t] - £20,000

For t = 1: NPV = £154,000 / (1 + 0.17)^1 = £131,966.10

For t = 2: NPV = £154,000 / (1 + 0.17)^2 = £112,423.87

...

For t = 8: NPV = £154,000 / (1 + 0.17)^8 = £57,831.43

Summing up all the NPVs for each year:

NPV = £131,966.10 + £112,423.87 + ... + £57,831.43 = £607,526.12

Conclusion:

Based on the NPV calculations for both options, the NPV of Making (Continuing Indigenous
Manufacturing) is £528,558.18, whereas the NPV of Buying (Accepting Smart Engineers’ Offer) is
£607,526.12. Thus, the financial appraisal supports the recommendation to continue with indigenous
manufacturing as it offers a higher NPV and aligns better with the long-term interests of Stork
Engineering. However, it is essential for the company to consider the potential risks and explore
alternatives to mitigate these risks and ensure a sustainable and successful future.