CASE STUDY

Samco Plc is a manufacturer of electric drills. Model has just developed two new models of
electric drills. Model 1 is called Automatic and model 2 is called super. Senior managers have
resolved that if production were to commence in making the automatic model, 200,000 drills per
annum will be produced and sold over the next five years at a price of £200 per drill, whereas if
production were to commence with the super model, 150,000 drills per annum will be sold over
the next seven years at a price of £140 per drill. Budgeted operating costs of each of the two
models at today’s prices are as stated below.
Automatic model £
Direct material 70
Direct Labor 20
Variable overhead 15
Fixed production overhead 15
Selling, Distribution etc 20

Net Cash inflow per unit = (£200- £140) = £60

Super model £
Direct material 20
Direct Labor 12
Variable overhead 15
Fixed production overhead 10
Selling, Distribution etc 13

An extension will be required to the existing property production to commence at a cost of £20m
if the automatic model was the preferred choice. If the super model was the preferred option then
the extension will only cost £17m. Corporation tax is paid at 30%. Shareholders of Samco Plc
expect a money rate of return of 15 % per annum after the tax from projects similar to the
automatic model but 20% for projects similar to the super model. Inflation is expected to be at
5% per annum for the next seven years. Operating cash flows for the purposes of the above
information can be assumed to take place at year-ends. There is a one year delay in the payment
of taxation to the tax authorities.
Your task is to use the net present value method to justify which of the two models Samco
Plc should undertake having taken into consideration all available information.