please show all calculations, and incorporate the tax and the depreciation when
ID: 2559661 • Letter: P
Question
please show all calculations, and incorporate the tax and the depreciation when needed in the three options that are given.
Black Knights Manufacturing is a national manufacturer of specialty sensors. The Shreveport, Louisiana plant will shut down on December 31, 2017. Audie Murphy, the Corporate Controller has been asked by Jack Pershing, Chief Financial Officer, to look at three different options for the plant: Option 1: The plant, which has been fully depreciated for tax purposes, can be sold immediately for $425,000 Option 2: The plant can be leased to Midshipmen Manufacturing, (one of Black Knights suppliers), for four years. Under the terms of the lease, Midshipmen would make 4 annual lease payments of $125,000 (payable at year end) and Midshipmen would grant Black Knights a $25,000 annual discount off the normal price of circuit boards purchased by Black Knights. Under the rental agreement, Midshipmen would bear all of the plant's ownership costs. Black Knights expects to be able to sell the plant for $70,000 at the end of the four-year lease. Option 3: The plant could be used for four years to make specialty door sensors for General Motors. Fixed manufacturing overhead costs before equipment upgrades are estimated to be $12,500 annually for the four year-period. The sensors are expected to sell for $70 each. Variable cost per unit is expected to be $57. The following production AND sales of sensors are expected to be: 2018 8,000 units; 2019 15,000 units; 2020 17,000 units; 2021 4,000 units. To facilitate production of the specialty sensors, some of the plant's equipment would need to be immediately upgraded at a cost of $88,000. The upgraded equipment has no salvage value and will be depreciated under the straight-line method over the four years it would be in use. Because of the upgrades, Black Knights could sell the plant for $150,000 at the end of the four years. Black Knights treat all cash flows as if they occur at the end of the year. The company uses an after tax required rate ofreturn of 12%. Black Knights is subject to a 34% tax rate on all income. Calculate net present value of each of the options and determine which option Black Knights should select. 1. 2. What nonfinancial factors should Black Knights consider before making its decision?Explanation / Answer
Black & Night Manufacturing Company should opt for Option 2 ( Leaseing the plant to Midshipmen Manufacturing) Because in this Option Black & Night get the highest return among the 3 optons . Black & Night can think of resuming manufacturing after the lease period if they wish to do. Due to the good relationship with Midshipmen they could extend the discount even after the lease period which can benefit Black & Night. The detailed workings are given below
Black & Night Manufacturing Company Net Present Value-Option 1 (Sale of Plant) Particulars 2018 2019 2020 2021 Sale of Plant $425,000 0 0 0 Tax $144,500 Profit after Tax $280,500 Return @ 12% after Tax(calculated on the 2018 Profit after Tax) $33,660 $33,660 $33,660 Total Income at the end of 4 th year $ 381,480 Black & Night Manufacturing Company Net Present Value-Option 2 (Lease) Particulars 2018 2019 2020 2021 Income from Lease $125,000 $125,000 $125,000 $125,000 Discounts on Circuit board purchase $25,000 $25,000 $25,000 $25,000 Sale value of Plant after 4 years $70,000 Tax 51000 51000 51000 74800 Profit after Tax $99,000 $99,000 $99,000 $145,200 Total Income at the end of 4 th year $ 442,200 Black & Night Manufacturing Company Net Present Value-Option 3 (Manufacture) Particulars 2018 2019 2020 2021 Expected Production 8000 15000 17000 4000 Income from Sale of Sensors @ $70 per unit $560,000 $1,050,000 $1,190,000 $280,000 Sale of Plant after 4 years $150,000 Fixed Mfg OH cost $12,500 $12,500 $12,500 $12,500 Variable cost @ $57 per unit $456,000 $855,000 $969,000 $228,000 Depreciation on SLM method
on Machine Upgrade cost of $88000 $22,000 $22,000 $22,000 $22,000 Total Expenses $490,500 $889,500 $1,003,500 $262,500 Net Income $69,500 $160,500 $186,500 $167,500 Tax @ 34% $23,630 $54,570 $63,410 $56,950 Profit after Tax $45,870 $105,930 $123,090 $110,550 Total Income at the end of 4 th year $ 385,440
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