The board of directors of Portand Ltd are considering two mutually exclusive investments each of which is expected to have a life of five years. The company does not have the physical capacity to undertake both investments. The first investment is relatively capital intensive whilst the second is relatively labour intensive. Forecast profits of the two investments are:
Investment 1 (requires four new workers)

Investment 2 (requires nine new workers)

1Depreciation is a tax allowable expense and is at 25 per cent per year on a reducing balance basis. Both investments are of similar risk to the company's existing operations.
Additional information
(i) Tax and depreciation allowances are payable/receivable one year in arrears. Tax is at 25 per cent per year.
(ii) Investment 2 would be financed from internal funds, which the managing director states have no cost to the company. Investment 1 would be financed by internal funds plus a £150 000, 14 per cent fixed rate term loan.
(iii) The data contains no adjustments for price changes. These have been ignored by the board of directors as both sales and production costs are expected to increase by 9 per cent per year, after year one.
(iv) The company's real overall cost of capital is 7 per cent per year and the inflation rate is expected to be 8 per cent per year for the foreseeable future.
(v) All cash flows may be assumed to occur at the end of the year unless otherwise stated.
(vi) The company currently receives interest of 10 per cent per year on short-term money market deposits of £350 000.
(vii) Both investments are expected to have negligible scrap value at the end of five years.
Director A favors Investment 2 as it has a larger average profit. Director B favours Investment 1 which she believes has a quicker discounted payback period, based upon cash flows.
Director C argues that the company can make £35 000 per year on its money market investments and that, when risk is taken into account, there is little point in investing in either project.
Required:
(a) Discuss the validity of the arguments of each of Directors A, B and C with respect to the decision to select Investment 1, Investment 2 or neither.
(b) Verify whether or not Director B is correct in stating that Investment 1 has the quicker discounted payback period. Evaluate which investment, if any, should be selected. All calculations must be shown. Marks will not be deducted for sensible rounding. State clearly any assumptions that you make.
(c) Discuss briefly what non-financial factors might influence the choice of investment.

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(E000) Year 1 (500) Initial cost Projected sales Production costs Finance charges Depreciation Profit before tax Average profit 400 450 500 550 600 260 300 350 450 500 21 21 21 21 21 125 94 70 53 40 (6) 35 59 26 39 before tax £30600. (£000) 0 1 23 4 5 Year (175) Initial cost Projected sales Production costs Depreciation Profit before tax Average profit 500 600 640 640 700 460 520 550 590 630 44 33 25 18 14 4) 4 65 32 56 before tax £39 200.