Shaftel Ready Mix is a processor and supplier of concrete, aggregate, and rock products. The company operates
Question:
In setting up the new plant, land would have to be purchased and a small building constructed. Equipment and furniture would not need to be purchased; these items would be transferred from a plant that opened in Wyoming during the oil boom period and closed a few years after the end of that boom. However, the equipment needs some repair and modifications before it can be used. The equipment has a book value of $ 200,000, and the furniture has a book value of $ 30,000. Neither has any outside market value. Other costs, such as the installation of a silo, well, electrical hookups, and so on, will be incurred. No salvage value is expected. The summary of the initial investment costs by category is as follows:
Land ................. $ 20,000
Building ................. 135,000
Equipment:
Book value .............. 200,000
Modifications ............. 20,000
Furniture (book value) ...........30,000
Silo .................20,000
Well ..................80,000
Electrical hookups ...........27,000
General setup .............50,000
Total ................. $ 582,000
Estimates concerning the operation of the Scottsdale plant follow:
After reviewing these data, Karl Flemming, vice president of operations, argued against the pro-posed plant. Karl was concerned because the plant would earn significantly less than the normal 8.3 percent return on sales. All other plants in the company were earning between 7.5 and 8.5 percent on sales. Karl also noted that it would take more than five years to recover the total initial outlay of $ 582,000. In the past, the company had always insisted that payback be no more than four years. The company€™s cost of capital is 10 percent. Assume that there are no income taxes.
Required:
1. Prepare a variable-costing income statement for the proposed plant. Compute the ratio of net income to sales. Is Karl correct that the return on sales is significantly lower than the company average?
2. Compute the payback period for the proposed plant. Is Karl right that the payback period is greater than four years? Explain. Suppose you were told that the equipment being transferred from Wyoming could be sold for its book value. Would this affect your answer?
3. Compute the NPV and the IRR for the proposed plant. Would your answer be affected if you were told that the furniture and equipment could be sold for their book values? If so, repeat the analysis with this effect considered.
4. Compute the cubic yards of cement that must be sold for the new plant to break even. Using this break-even volume, compute the NPV and the IRR. Would the investment be acceptable? If so, explain why an investment that promises to do nothing more than break even can be viewed as acceptable.
5. Compute the volume of cement that must be sold for the IRR to equal the firm€™s cost of capital. Using this volume, compute the firm€™s expected annual income. Explain this result.
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...
Step by Step Answer:
Cornerstones of Financial and Managerial Accounting
ISBN: 978-1111879044
2nd edition
Authors: Rich, Jeff Jones, Dan Heitger, Maryanne Mowen, Don Hansen