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Homework answers / question archive / A company is considering constructing a plant to manufacture a proposed new product
A company is considering constructing a plant to manufacture a proposed new product. The land costs $300,000, the building costs $600,000, the equipment costs $250,000, and $100,000 additional working capital is required. It is expected that the product will result in sales of $750,000 per year for 10 years, at which time the land can be sold for $400,000, the building for $350,000, and the equipment for $50,000. All of the working capital would be recovered at the EOY 10. The annual expenses for labor, materials, and all other items are estimated to total $475,000. If the company requires a MARR of 15% per year on projects of comparable risk, determine if it should invest in the new product line. Use the AWmethod.
We get the follwoing data from the above given question :-
Land costs = $300,000
Building costs = $600,000
Equipment costs = $250,000
Additional working capital required = $100,000
Expected Sales per year for 10 years = $750,000
Salvage Value of the following items after 10 years :-
Land cost = $400,000
Building cost = $350,000
Equipment cost = $50,000
All of the working capital would be recovered at the EOY 10 i.e. amount of working capital will be = $100,000
Annual expenses = $475,000
MARR = 15% per annum or, 0.15 per annum
Therefore, the total amount of investment in the project = ($300,000 + $600,000 + $250,000 + $100,000)
= $1,250,000
Expected sales per annum = Annual revenue = $750,000
Annual Expenditure = $475,000
As we know, Net Income = Revenue - Expenses
Thus, Net Income of the project per year = ($750,000 - $475,000) = $275,000
Worth or valuation of the invetment in the project after 10 years = Total salvage value + Recovered Additional WC
= ($400,000 + $350,000 + $50,000 + $100,000)
= $900,000
Capital Recovery Factor where the MARR is given @ 15% per annum for 10 years is given by :-
(A/P, i% ,n) = {i * (1+i)n} / {(1+i)n - 1}
Or, (A/P, 15%, 10) = {0.15 * (1+0.15)10} / {(1+0.15)10 - 1}
= (0.15 * 4.045558) / (4.045558 - 1)
= 0.199
Sinking Fund Factor where the MARR is given @ 15% per annum for 10 years is given by :-
(A/F, i%, n) = i / {(1+i)n - 1}
Or, (A/F, 15%, 10) = 0.15 / (1+0.15)10 - 1
= 0.049
Therefore, the Net Annual Worth of the project :-
- Initial Investment (A/P, 15%, 10) + Annual Net Income + Salvage Value (A/F, 15%, 10)
= (-$1,250,000 * 0.199) + $275,000 + ($900,000 * 0.049)
= -$248,750 + $275,000 + $44,100
= $70,350
Since the net annual worth yields a positive value, investment is the new product line would be worth taking.
