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    Net present value

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    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 components 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, test 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. Which

    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 reequiped 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.

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    Solution Summary

    The solution explains how to choose among the alternatives using net present value