Saskatoon First Company must expand its manufacturing capabilities to meet the growing demand for its products. The first alternative is to expand its current manufacturing facility, which is located next to a vacant lot in the heart of the city. The second alternative is to convert a warehouse the company already owns, which is located 20 km out- side the city. Saskatoon First's controller obtains the following information to evaluate both proposals.
The plant and equipment investment to expand the current manufacturing facility is $19 million, while a $22-million investment is required to convert the warehouse. At either site, Saskatoon First needs to invest $3 million in working capital. Cash revenues from products made in the new facility are expected to equal $13 million each year. If the warehouse is converted, cash operating costs are expected to be $10 million per year. Expanding the current facility will increase efficiency: annual cash operating costs, if the current facility is expanded, will be $1 million less than the cash operating costs if the warehouse is converted. The controller uses a 10-year period and a 14% required rate of return to evaluate manufacturing investments. The estimated disposal price of the new facility (including a recovery of working capital of $3 million) at the end of 10 years is $8 million at both locations. Saskatoon First depreciates the investment in plant and equipment using straight-line depreciation over 10 years on the difference between the initial investment and the disposal price.
Instructions
Calculate the net present value of the proposals to expand the current manufacturing facility and to convert the warehouse. Which project should Saskatoon First choose based on the NPV calculations?