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Accounting - Choosing Between Two Alternative Plans

Situation: The firm builds thrill rides for amusement and theme parks. The rides are engineered at its headquarters in Tampa, Florida in collaboration with engineers in India and China. Once designed, production plans are engineered by a firm in Malaysia. The component parts of the rides are manufactured in Mexico and Tampa. The parts are then shipped to the sight of the park where a team assembles the rides, tests them, and train the parks' ride maintenance employees on inspection and upkeep on the rides. It has been difficult finding machinists and pipefitters in Tampa, but Mexico has a surplus of this labor skill. A plan has been forwarded to upper management to add a new factory in Mexico. Below are the detailed needs for two alternative plans, one which is more labor intensive than the other.

A. Which alternative should be adopted? Use net present value to decide. Show calculations for each alternative on the respective worksheet.

B. If you think there are qualitative factors to consider beside the quantitative analysis explain what they might be.
Note - put final conclusion and part B at the bottom of this worksheet.

Data to be considered

Revenue is not a relevant item since it will be the same using either plant. The cost structures of the two plants will be different since one plan is labor intensive while the other has several automated processes.

The Tampa plant will be sold to help fund this new plant but is not relevant:

Selling price of land and plant $ 3,000,000
Tax basis of land $ 50,000
Tax basis of plant:
Original cost $ 4,500,000
Accumulated depreciation $ 3,500,000
Tax basis $ 1,000,000
Gain on the sale $ 1,950,000

Under alternative one the equipment will be shipped to Mexico at a cost of $500,000. In such a case the remaining tax value of $1,000,000 will be depreciated over four years on a straight line basis ($250,000 annually).

Under alternative two all new equipment will be purchased so the Tampa equipment will
be sold as follows:

Selling price $ 1,500,000
Tax basis of the equipment:
Original cost $ 5,000,000
Accumulated depreciation $ 4,000,000
Tax basis (mentioned above) $ 1,000,000
Gain on the sale $ 500,000

Under either alternative new equipment will depreciated on a straight line basis over 10 years. The plant will be depreciated over 20 years on a straight line basis.

The plant will be re-equipped after the ten years, so assume that the life of the project is ten years.

Tax rate of the firm 40.00%
Firm's cost of capital 12.00%

One Two

Initial costs:

Land ($1,000,000 not relevant since it is the same cost under either alternative)
New plant $ 3,500,000 $ 5,000,000
New equipment $ 2,000,000 $ 3,500,000

Annual operating cost that will be different among the two alternatives:
Direct labor $ 5,000,000 $ 3,000,000
Overhead costs $ 2,000,000 $ 3,000,000
Equipment overhaul at end of year 5 $ 2,000,000 $ -
Disposal value of equipment in year 10 $ 0 $ 1,000,000
Working capital needs $ 300,000 $ 500,000

Note - working capital is freed up at end of year 3 under either alternative.


Solution Summary

The expert chooses between two alternative plans in accounting.