Krasner Corporation is a diversified company with several manufacturing plants.
ID: 2432522 • Letter: K
Question
Krasner Corporation is a diversified company with several manufacturing plants. Krasner’s
Houston Plant has been supplying parts to truck manufacturers for over 20 years. The last
shipment of truck parts from the Houston Plant will be made on December 31, 2018. Krasner’s
management is currently evaluating three alternatives relating to its soon-to-be-idle plant and
equipment in Houston.
Pufong Industries has offered to buy the Houston Plant for $3,000,000 cash on January 7, 2019.
Barreau Enterprises has offered to lease the Houston facilities for 4 years beginning on January 1, 2019. Barreau’s annual lease payments would be $500,000 plus 10%
of the gross dollar sales of all items produced in the Houston Plant. Probabilities of
Barreau’s annual gross dollar sales from the Houston Plant are estimated as follows:
Annual Gross Dollar Sales Estimated Probability
$2,000,000 .1
4,000,000 .4
6,000,000 .3
8,000,000 .2
Krasner is considering the production of souvenir items to be sold in connection
with upcoming sporting events. The Houston Plant will be used to produce 70,000
items per month at an annual cash outlay of $2,250,000 during 2019, 2020, and 2021.
Ashley Payne, Vice President of Marketing, has recommended a selling price of $5
per item and believes the items will sell uniformly throughout 2019, 2020, and 2021.
The adjusted basis of the Houston Plant as of the close of business on December 31, 2018 will be $4,200,000. Krasner has used straight-line depreciation for all capital
Assets at the Houston Plant. If the Houston Plant is not sold, the annual straight-line
Depreciation expense for the plant and equipment will be $900,000 for the next 4 years. The market value of the plant and equipment on December 3, 2021 is estimated to be $600,000.
Krasner requires an after-tax rate of return of 16% for capital investment decisions
and is subject to a corporate tax rate of 40% on all income.
Calculate the present value at December 31, 2021 of the expected after-tax cash flows for each of the three alternatives available to Krasner Corporation regarding the Houston Plant. Assume all recurring cash flows take place at the end of the year.
Discuss the additional factors, both quantitative and qualitative, Krasner Corporation should consider before a decision is made regarding the disposition or use of the idle plant and equipment at the Houston plant
This question was answered but please can you show me the workings, how the Present value was gotten?
Thanks
Explanation / Answer
Alternative 1 Pufong Industries' offer to buy After-tax cash inflow 3000000*(1-40%)= 1800000 Alternative 2 Barreau Enterprises lease offer PV of 4 end- of- year Lease payments End Year Fixed amount After-Tax sales $ (Gross sales*(1-40%) Probabilty Probable sales(AT Sales*prob.) 10%*prob. Sales Fixed amt.+10%*Prob.sales PV F at 16% PV at 16% 1 500000 1200000 0.1 120000 12000 512000 0.86207 441379 2 500000 2400000 0.4 960000 96000 596000 0.74316 442925 3 500000 3600000 0.3 1080000 108000 608000 0.64066 389520 4 500000 4800000 0.2 960000 96000 596000 0.55229 329165 Total PV of 4 end -of -year Lease payments 1602990 Alternative 3 Production of souvenir items in Houston plant Year 0 Yr 1(2019) Yr.2(2020) Yr.3(2020) Yr.4(2021) Annual cash outlay -2250000 -2250000 -2250000 Sales cash inflows(70000*12mths.* $ 5) 4200000 4200000 4200000 Less: Depreciation (4200000/3) -1400000 -1400000 -1400000 EBT 550000 550000 550000 Less:Tax at 40%*EBT -220000 -220000 -220000 EAT 330000 330000 330000 Add Back depn. 1400000 1400000 1400000 Operating cash flows 1730000 1730000 1730000 Less: Depn. Tax shield lost(900000*40%) -360000 -360000 -360000 -360000 Add: After-tax salvage(600000*(1-40%) 360000 NET annual cash flows 0 1370000 1370000 1370000 0 PV F at 16% 1 0.86207 0.74316 0.64066 0.55229 PV at 16% 0 1181034 1018133 877701 0 NPV as at Jan 1, 2019 3076869 As the third alternative,ie. To produce sovenir items utilising the idle capacity at the Houston plant fetches the highest NPV ($ 3076869) , the same is recommended. Qualitatively, also, it is a better option as that will not be displacing any of the existing workforce . Also, the market can be explored with the new production , with the existing plant , without having to spend any additional amounts on capital outlay.
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