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A company is considering building a new and improved production facility for one of its existing products. It would be built on a piece of vacant...
A company is considering building a new and improved production facility for one of its existing products. It would be built on a piece of vacant land that the firm owns. This land was acquired four years ago at a cost of $500,000; it has a current market value of $800,000. The building can be erected for $600,000. Machinery (equipment) worth $120,000 needs to be bought. The company will finance the construction of the building and the purchase of the equipment by borrowing $720,000 for 10 years at 10% interest. Interest will be paid annually and the full amount of the loan will be repaid in one payment at the end of the 10 years. The company’s net working capital will increase by $100,000 if the new production facility is built. Operating savings from the new production facility are expected to be $300,000 per year for the next 10 years. The total fair market value (salvage value) of the assets at the end of the 10 years is expected to be $1,000,000− one quarter of which is attributable to the building and equipment. The building and equipment will be amortized on a straight-line basis over 10 years. The firm’s tax rate is 40 percent and CCA will be taken on all depreciable assets at a rate of 20%. The firm’s weighted average cost of capital (WACC) is estimated at 15 percent. Should the company build the new and improved production facility? Round final dollar amounts (in each category) to closest dollar (i.e., ignore cents). (13 marks)
[NOTE: Although not realistic, the question assumes that the construction of the building will be completed “immediately”. Thus, the operating savings are realized starting Year 1.]
