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Harding Ltd manufactures, installs and maintains Eco-Friendly Heating Systems for hotels. Their most recent financial statements are set out below:
|Statement of Financial Position as at 31 December 2019|
|Plant and Equipment||832.80|
|Cash at Bank||27.60|
|EQUITY AND LIABILITIES|
|€1.50 Ordinary Shares||600.00|
|Non – Current Liabilities|
|12% Loan Notes||375.00|
|Total Equity and Liabilities||2345.55|
|Income Statement for the year ended 31 December 2019|
|Profit Before Tax||768.00|
|Tax at 25%||192.00|
|Profit After Tax||576.00|
A dividend of €230,400 was proposed and paid during the year. The business wishes to invest in more plant and equipment in order to cope with an expected increase in demand. Additional operating profit (profit before interest and tax) of €180,000 per year is expected if an investment of €600,000 is made in plant and equipment.
The directors are considering an offer from a private equity firm to finance the proposed expansion. The finance will be made available immediately through either :
The directors wish to maintain the same dividend payout ratio in future years as in past years, whichever method of finance is chosen.
The company uses simple payback to evaluate capital investment projects such as the one proposed. Included in the projected increase in operating profit of €180,000 in depreciation per year of €30,000. The company considers capital investment projects with a payback period of fewer than 3 years to be worthwhile.
Prepare a report for the board of Harding Limited. The report should address all of the requirements raised.
Advise the company on the weaknesses of simple payback and why they should consider using the net present value as a more robust method to evaluate capital investment projects.