The Liquid Chemical Company manufactures and sells a range of high-grade products. Many of these products require
Question:
Walsh also worried about the workers if he closed the department. I dont think we can find room for any of them elsewhere in the firm. However, I believe Packages would take all but Hines and Walters. Hines and Walters have been with us since they left school 40 years ago. Id feel bound to give them a supplemental pension$15,000 a year each for five years, say. Also, Id figure a total severance pay of $20,000 for the other employees, paid in a lump sum at the time we sign the contract with Packages. Duffy showed some relief at this. But I still dont like Dyers figures, he said. What about this $225,000 for general administrative overheads? You surely dont expect to sack anyone in the general office if Im closed, do you? Walsh agreed. Well, I think weve thrashed this out pretty well, said Walsh, but Ive been turning over in my mind the possibility of perhaps keeping on the maintenance work ourselves. What are your views on that, Duffy? I dont know, said Duffy, but its worth looking into. We wouldnt need any machinery for that, and I could hand the supervision over to the current supervisor who earns $50,000 per year. Youd need only about one-fifth of the workers, but you could keep on the oldest and save the pension costs. Youd still have the $20,000 severance pay, I suppose. You wouldnt save any space, so I suppose the rent would be the same. I dont think the other expenses would be more than $65,000 a year. What about materials? asked Walsh. We use 10 percent of the total on maintenance, Duffy replied. Well, Ive told Packages that Id give them my decision within a week, said Walsh. Ill let you know what I decide to do before I write to them. Assume the company has a cost of capital of 10 percent per year and uses an income tax rate of 40 percent for decisions such as these. Liquid Chemical would pay taxes on any gain or loss on the sale of machinery or the GHL at 40 percent. (Depreciation for book and tax purposes is straight-line over eight years.) The tax basis of the machinery is $600,000. Also assume the company had a five-year time horizon for this project and that any GHL needed for Year 5 would be purchased during Year 5.
Required
a. What are the four alternatives available to Liquid Chemical?
b. What action should Walsh take? Support your conclusion with a net present value analysis of all the mutually exclusive alternatives. Be sure to consider factors not explicitly discussed in the case that you think should have a bearing on Walshs decision.
c. What, if any, additional information do you think Walsh needs to make a sound decision?Why?
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... 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...
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Fundamentals of Cost Accounting
ISBN: 978-0077398194
3rd Edition
Authors: William Lanen, Shannon Anderson, Michael Maher