A company is considering constructing a plant to manufacture a proposed new prod

Question

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 the $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 $400000; the building sold 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 annual worth method here.

Explanation / Answer

Annual worth = Annual operating cost- Capital recovery(CR)

Annual Operating cost= 750000-475000=$275000

CR(i%)=I(A/P, i%, N)-S(A/F, i%, N)

where,
I= initial investment for the project
S=salvage(market) value at the end of the period
N=project period

=300000*(A/P,15%,10)-400000*(A/F,15%,10)

=300000*0.1992-400000*0.0492

CR for land=$40080

Similarly we have to calculate CR for building and equipment

CR for building=600000*(A/P,15%,10)-350000*(A/F,15%,10)

=600000*0.1992-350000*0.0492

CR for building=$102300

CR for equipment= 250000*(A/P,15%,10)-50000*(A/F,15%,10)

=250000*0.1992-50000*0.0492

CR for equipment=$47340

Annual Worth= 275000-(40080+47340+102300)

Annual Worth=$85280

As annual worth is +ve company should invest in the new product line

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