Rahim Corp is evaluating alternative uses for a 4-storey manufacturing and warehousing building that it purchased 2 months ago for $975,000.

Alternative One: Rent the building to its current occupants for $75,000 per year. These tenants are prepared to sign a 15-year lease.

Alternative Two: Rahim Corp would make leasehold improvements to the existing structure and use the structure for manufacturing a new product line which looks very promising. Rahims engineers and accountants have provided the following information:

• Initial cash outlays for building modifications: $102,000.
• Initial cash outlays for manufacturing equipment & installation: $382,000.
• Salvage value of manufacturing equipment: $25,000.
• Annual pre-tax cash revenues (generated for 15 years): $390,000.
• Annual pre-tax cash expenditures (generated for 15 years): $174,700.
• Initial working capital requirements: $75,000.
• Working capital released at the end of year 15: $75,000.

• Tax considerations.

1. The original building shell (purchased for $975,000) is CCA class 1 and has a 10% CCA rate.
2. Building modifications fall into CCA class 1 and have a 10% CCA rate.
3. The manufacturing equipment is CCA class 14 and has a CCA rate of 30%.

Salvage value of the Building & Restoration costs: At the end of year 15 it is estimated that the building could be sold for $1.5 million if the building is restored to its original state. Restoration costs for each alternative will be:

• Alternative One (if rent the building): $20,000.
• Alternative Two (manufacture new product line): $100,000.

Relevant information:

• Weighted average cost of capital: 16%
• Tax rate: 36%
• Assume all cash flows take place at the end of the year, except for the initial cash outlays which will occur at t = 0.

QUESTIONS:

1. Which of the two alternative uses of the building would you recommend (show all calculations)?