Expand Your Critical Thinking 25-02 d (Essay)

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Hawke Skateboards is considering building a new plant. Bob Skerritt, the companys marketing manager, is an enthusiastic supporter of the new plant. Lucy Liu, the companys chief financial officer, is not so sure that the plant is a good idea. Currently, the company purchases its skateboards from foreign manufacturers. The following figures were estimated regarding the construction of a new plant.

Cost of plant		$4,000,000		Estimated useful life		15 years
Annual cash inflows		4,000,000		Salvage value		$2,000,000
Annual cash outflows		3,540,000		Discount rate		11%

Bob Skerritt believes that these figures understate the true potential value of the plant. He suggests that by manufacturing its own skateboards the company will benefit from a buy American patriotism that he believes is common among skateboarders. He also notes that the firm has had numerous quality problems with the skateboards manufactured by its suppliers. He suggests that the inconsistent quality has resulted in lost sales, increased warranty claims, and some costly lawsuits. Overall, he believes sales will be $200,000 higher than projected above, and that the savings from lower warranty costs and legal costs will be $60,000 per year. He also believes that the project is not as risky as assumed above, and that a 9% discount rate is more reasonable.

		NPV
Based on original projections		$(274,200)
New projections using the 11% rate		$1,595,426
Original projections using the 9% rate		$256,997

(d) Comment on the Net present values.