ProblemB -Multiple Options

"I don't know whether to sell it, expand it, lease it, or what. But I don't think we can keep doing the same thing formanymore years.WhatIreallywanttodoistokeepitfor5more years,thensellitforabundle,"ElmerKettlersaidto his wife, Janise, their son, John Kettler, and new daughter-in-law, Suzanne Gestory, as they were gathered aroundthe dinner table. Elmer was sharing thoughts on Gulf Coast Wholesale Auto Parts, a company he has owned andoperatedfor25yearsonthesouthernoutskirtsofHouston,Texas.Thebusinesshasexcellentcontractsforpartssupplywith several national retailers operating in the areaNAPA, AutoZone, O'Reilly, and Advance. Additionally, GulfCoast operates a rebuild shop serving these same retailers for major automobile components, such as carburetors,transmissions,andairconditioningcompressors.

Athishomeafterdinner,Johndecidedtohelphisfatherwithanimportantanddifficultdecision:Whattodowithhisbusiness? John graduated just last year with an engineering degree from a major state university in Texas, where hecompleted a course in engineering economy. Part of his job at Energcon Industries is to perform basic rate of returnand presentworthanalyseson energymanagementproposals.

Information

Over the next few weeks, John outlined five options,including his dad's favorite of selling in 5 years. Johnsummarized all the estimates over a 10-year horizon. The options and estimates were given to Elmer, and he agreedwiththem.

Option 1: Remove rebuild.Stop operating the rebuild shop and concentrate on selling wholesale parts. The removaloftherebuildoperationsandtheswitchtoan"all-partshouse"areexpectedtocost$750,000inthefirstyear.Overallrevenueswilldropto$1millionthefirstyearwithanexpected4%increaseperyearthereafter.Expensesareprojectedat$0.8millionthefirstyear, increasing6%peryear thereafter.

Option 2: Contract rebuild operations.To get the rebuild shop ready for an operations contractor to take over willcost $400,000 immediately. If expenses stay the same for 5 years, they will average $1.4 million per year, but theycan be expected to rise to $2 million per year in year 6 and thereafter. Elmer thinks revenues under a contractarrangementcanbe$1.4 millionthefirstyearandcanrise5%peryearforthedurationof a10-yearcontract.

Option 3: Maintain status quo and sell out after 5 years(Elmer's personal favorite). There is no cost now, but thecurrenttrendofnegativenetprofitwillprobablycontinue.Projectionsare$1.25millionperyearforexpensesand

$1.15 million per year in revenue. Elmer had an appraisal last year, and the report indicated Gulf Coast WholesaleAuto Parts is worth a net $2 million. Elmer's wish is to sell out completely after 5 more years at this price, and tomake a deal that the new owner pay $500,000 per year at the end of year 5 (sale time) and the same amount for thenext3years.

Option4:Trade-out.Elmerhasaclosefriendintheantiqueautopartsbusinesswhoismakinga"killing,"sohesays,with e-commerce. Although the possibility is risky, it is enticing to Elmer to consider a whole new line of parts, butstill in the basic business that he already understands. The trade-out would cost an estimated $1 million for Elmerimmediately. The 10-year horizon of annual expenses and revenues is considerably higher than for his currentbusiness.Expensesare estimated at$3millionperyear and revenuesat$3.5millioneach year.

Option5:Leasearrangement.GulfCoastcouldbeleasedto someturnkeycompanywithElmerremainingtheownerandbearingpartoftheexpensesforbuilding,deliverytrucks,insurance,etc.Thefirst-cutestimatesforthisoptionare

$1.5milliontogetthebusinessreadynow, withannualexpensesat$500,000peryearandrevenuesat$1millionperyearfor a 10-year contract.

Questions:

HelpJohnwiththeanalysisbydoingthefollowing:

1. Develop the actual cash flow series and incremental cash flow series (in $1000 units) for all five options inpreparationfor anincrementalIRRanalysis.
2. IfJohn'sfatherinsiststhathemake25%peryearormoreontheselectedoptionoverthenext10years,whatshould he do? Use all the methods of economic analysis you have learned so far (PW, AW, FW, IRR) soJohn'sfathercan understandthe recommendationinonewayor another.