the lucky seven company is an international clothing manufacturer. its Redmond p
ID: 2454759 • Letter: T
Question
the lucky seven company is an international clothing manufacturer. its Redmond plant will become idle on December 31, 2015. Peter laney, rhe corporate controller, has been asked to look at three options regarding the plant.
a) the plant, which has been fully depreciated for tax purposes, can be sold immediately for $450,000.
b)the plant can be leased to the preston corporation, one of lucky seven's suppliers, for four years. under the lease terms, preston would pay lucky seven $110,000 rent per year (payable at year_end) and would grant lucky seven a $20,000 annual discount off the normal price of fabric purchased by lucky seven. preston would bear all of the plant's ownership costs. lucky seven expects to sell this plant for $75,000 at the end of the four year lease.
c) the plant could be used for four years to make aoubenir jackets for the olympics. fixed overhead costs before any equipmen t upgrades are estimated to be $10,000 annually for the four-year period. the jackets are expected to sell for $55 each. variable cost per unit is expected to be $43. the following production and sales of jackets are expected: 2015, 9,000 units; 2016, 13,000 units; 2017, 15,000 units; 2018, 5,000 units. in order to manufacture the jackets, some of the plant ewuipment would need to be upgraded at an immediate cost of $80,000. the equipment would be depresiated using the straight-line depreciation method and zero terminal disposal value over the four years it would be in use. because of the equipment upgrades, lucky seven could sell the plant for $135,000 at the end of four years. no change in working capital would be required. lucky seven treats all cash flows as if they occur at the end of the year, and it uses an after-tax required rate of return of 10%. lucky seven is subject to a 35% tax rate on all income, including capital gains.
1) calculate net present value of each of the options and determine which option lucky seven should select using the NPV criterion.
2)what nonfinancial factors should lucky seven consider before making its choice?
Explanation / Answer
I. Lease option:
Annual lease rent = $110000
Saving in annual cost = $20000
Salvage value at the end of four year = $75000
Annual Cash inflows after tax = [(110000+20000)*0.65) = $84500
NPV = Present Value of Cash inflows = [84500*3.170] + [75000*0.683]
= $319090
II. Manufacturing option:
Contribuiton per unit = 55-43 = $12
Cash inflows per year
NPV = Total Present value of cash inflows
= $312612
III. Sale option:
NPV = $450000
Therefore, Lucky seven should select the sale option.
Year 1 2 3 4 No.of units * Contribution = Total contribution 108000 156000 180000 60000 - Fixed Cost -10000 -10000 -10000 -10000 Profit from operations 98000 146000 170000 50000 Profit after tax 63700 94900 110500 32500 Salvage value after tax 87750 Cash inflows after tax before tax saving on depreciation 63700 94900 110500 120250 Tax saving on depreciation 3500 3500 3500 3500 Total cash inflows per year 67200 98400 114000 123750 PVF @ 10% 0.909 0.826 0.752 0.683 Present Value of cash inflows 61085 81278 85728 84521Related Questions
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