PART B

9. Skyjets, an aircraft manufacturing company, invested £200 million five years ago to build a factory for producing wing parts. The factory is now ready. Over the next twenty years that it will be operational, it is expected to generate £200 million in revenues and £25 million in operating costs (including depreciation for the assets, the cost of financing the project, etc). However, the board of directors of the company is considering whether it is worth investing in a new factory, which will adopt the latest manufacturing technology. The new factory would yield £400 million in revenues, £50 million in operating costs, and it would cost £200 million to build. If the old factory is abandoned it would have £0 value to the company.

a. Calculate the accounting profit of the new factory.

b. Calculate the economic profit of the new factory. Should Skyjets go ahead with the new project and why/why not?

c. Suppose that the company decides to go ahead with the construction of the new factory. After the construction starts, the construction company claims that building costs have increased from £200 million to £300 million. Assuming that the old factory is already scrapped at this stage, should the project still go ahead? What could the company have done to protect itself from this hold-up?