economics problem. Thank you! A company is considering constructing a plant to m
ID: 1113989 • Letter: E
Question
economics problem. Thank you!
A company is considering constructing a plant to manufacture a proposed new product. The land costs S350,000, the building costs $650,000, the equipment costs $200,000, and $100,000 additional working capital is required. It is expected that the product will result in sales of $850,000 per year for 9 years, at which time the land can be sold for $400,000, the building for $400,000, and the equipment for $50,000. All of the working capital would be recovered at the EOY 9. The annual expenses for labor, materials, and all other items are estimated to total $525,000. If the company requires a MARR of 12% per year on projects of comparable risk, determine if it should invest in the new product line. Use the AW methodExplanation / Answer
Working notes:
(1) Year 0 costs ($) = Land + Building + Equipment + Working capital
= 350,000 + 650,000 + 200,000 + 100,000 = 1,300,000
(2) Net annual benefit (NAB) ($), Years 1-8 = Annual revenue - Annual expenses = 850,000 - 525,000 = 325,000
(3) NAB, year 0 = Costs = - $1,300,000
(4) NAB, year 9 ($) = Annual revenue - Annual expenses + Sale value of Land, building & equipment + Recovery of working capital
= 325,000 + 400,000 + 400,000 + 50,000 + 100,000 = 1,275,000
Therefore,
AW ($) = - 1,300,000 x A/P(12%, 9) + 325,000 + 1,275,000 x P/F(12%, 9) x A/P(12%, 9)
= - 1,300,000 x 0.1877** + 325,000 + 1,275,000 x 0.3606** x 0.1877**
= - 244,010 + 325,000 + 86,298
= 167,288
Since AW is positive, company should invest in the product line.
**From A/and P/F Factor tables.
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