Please refer to the above information and answer step 2 of Part 2

Part 2 - Capital Budgeting (60 marks) 1800 words EH Logistics is a package handling company that provides service to an e-commerce company MS Incorporated which is just like Amazon. EH Logistics is a fairly new company in the market. Currently EH Logistics has employed labour to handle packages that have to be sent to the customers of MS Incorporated. However, recently there is a sudden increase in the demand for the products sold by MS Incorporated. Hence there is increased demand for package handling. In view of this development, and recognizing the limitations of manual package handling, the managers of EH Logistics are thinking of automating the package handling process by purchasing some state- of-the-art machines. The advantage of using machines is that it would significantly reduce the handling time required per package, thereby potentially allowing the company to take on more orders at a time. However, there would be significant capital expenditure to acquire the machines, which would significantly increase the cost of capital. The time line for this investment decision is 15 years. Although the process is less efficient, EH Logistics could use its current labour force to meet the increased demand. Step 1: The Chief Financial Officer must decide whether to go with the labour intensive option or the capital intensive option (details of these projects are outlined on the following page). She has requested that your team should calculate the Net-Present-Value (NPV) and provide a recommendation as to which option to take. In your team, prepare a clear recommendation that includes the following details: a) A rationale for why or why not the incremental approach to calculate the NPV is appropriate for this kind of decision. b) The NPV and internal rate of return for the proposed labour intensive project (include calculations). c) The NPV of the proposed capital intensive project (include calculations).d) Clearly indicate of which project you would recommend and why you are recommending this one over the other. Labour Intensive Option Capital Intensive Option If EH Logistics sticks to labour to handle packages then: I It can pack 600,000 units in year 1 and this number will likely to go up by 120% in year 2, 10% in year 3 and 3.31% in year 4 compared to the previous years. It is expected to remain constant after that. o The packages are priced at $2 per package. I The company has invested $900,000 in buildings in the current year. The buildings will be used for handling the packages. The buildings are fully furnished and have good facilities for people to work comfortably. 0 EH Logistics estimated that the fixed cost for this arrangement is going to be $260,000 in the rst year, which includes set-up cost of $50,000. 0 Thereafter, the xed cost would be $210,000. 0 The variable cost per package is $1.40. 0 The buildings are fully depreciated in 15 years {at an annual rate of $60,000) for tax purposes. However, the salvage value ofthe buildings is $285,000. 0 There will be a further increase in net working capital of $140,000, $14,000, $15000, $17000 and $20,000 for year 1, 2, 3, 4 and year 5 to year 15. I The tax rate is 30%. I The opportunity cost of capital for this project is 10%. I There is no recovery of working capital. If EH Logistics adopts the automation technology to handle packages then: 0 It has to invest in two instalments $1,900,000 in the current year and $1,400, 000 in year 1. 0 Unlike the labour technology, production will start from year 2. 0 With the automation process EH Logistics can pack 700,000 units in year 2 and this number will likely to go up by 107% in year 3, and then 10% each year in years 46, compared to the previous year. 0 The number then will go up by 3.5% compared to year 6 for in year 7 and then it will remain constant. 0 The price per unit package is $2. 0 The change in net working capital in year 2 is $160,000. 0 For the following 4 years the change in net working capital is $11,000, $17,000, $20,000, $24,000. 0 From year 7 to 15 the change in net working capital remains constant at $30,000. 0 To run and maintain the automation process EH Logistics has to incur xed cost of $210,000 in year 2 and $110,000 for the life of the project. 0 The variable cost per package is $1.15. The machines can be depreciated $167,000 per year for tax purposes. 0 EH Logistics can salvage $938,000 by selling the machines at the end of their useful lives. 0 Since this is a big investment, EH Logistics has to source fund from different sources. So the opportunity cost of capital for this project is 14% in year 1 and 2, 11% in year 3 and then 9% for the rest of the years. 0 The tax rate is 30%. 0 There is no recovery of working capital. Step 2: Just before you finalise the recommendation, the EH Logistics CFO advises you that MS Incorporated have pledged to only use the services of suppliers and distributors that meet its sustainability guidelines, which includes a requirement that packaging be comprised of at least 90% recycled materials. EH Logistics currently uses packaging that is comprised of 50% recycled materials. The date from which MS plan this change to take effect is exactly five years after the planned commencement of the investment. The CFO asks you to reconsider the two investment options and determine how this new requirement would impact your recommendation. To meet the requirements, for the labour intensive option there will be an increased in fixed cost $100,000 each year from year 5 to source suitable packaging materials. To meet the requirements for the capital intensive option, the old machinery will be traded in and there would be an additional cost of $2, 000,000 to accommodate the purchase of a different model of machinery that can operate with the alternative packaging materials. There would also be the increased cost of $200,000 each year from year 5 to source suitable packaging materials. The new machine will be evenly depreciated over the next 10 years. There will be no salvage value. Assume the production will start from year 6. In your team, calculate the differences to the NPV for each of the two options and prepare a supplementary recommendation that includes the following details: a) A summary of the impact of MS's sustainability pledge on this investment decision and your revised recommendation on which option to follow. b) Any additional sustainability factors* that have the potential to impact the investment that the CFO has not asked you to consider and what this impact might look like. *Note: to complete Step 2b your team will need to research sustainable practices and draw on articles or other resources (appropriately cited) to support your explanation