A firm considers building a new and improved production facility for one of its

Question

A firm considers building a new and improved production facility for one of its existing products. It would be built on a piece of vacant land that the firm owns. This land was acquired four years ago at a cost of $200,000; it has a current market value of $1,000,000. The building can be erected for $350,000. Machinery worth $150,000 needs to be bought. Capital cost allowances on a declining balance will be taken on all depreciable assets at a rate of 20 percent. Operating savings from the new production facility are expected to be $300,000 per year for the next 10 years. The salvage value at the end of the 10 years is expected to be $1,500,000, which is solely the value of the land. The firm

Explanation / Answer

Due to positive NPV, the project should be accepted.

Particulars 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19 31-Dec-20 31-Dec-21 31-Dec-22 31-Dec-23 31-Dec-24 Cost of building -350000 21000 22000 19000 12000 9000 Cost of machinery -150000 Operating savings 350000 350000 350000 350000 350000 350000 350000 350000 350000 350000 Less - depreciation -50000 -40000 -32000 -25600 -20480 -16384 -13107 -10486 -8389 -6711 Net savings 300000 310000 318000 324400 329520 333616 336893 339514 341611 343289 Less - taxes 120000 124000 127200 129760 131808 133446 134757 135806 136645 137316 Savings after taxes 180000 186000 190800 194640 197712 200170 202136 203709 204967 205973 Add - dep 50000 40000 32000 25600 20480 16384 13107 10486 8389 6711 Net cash flows -500000 230000 226000 222800 220240 218192 216554 215243 214194 213355 212684 Disccounting rate 1.00 0.87 0.76 0.66 0.57 0.50 0.43 0.38 0.33 0.28 0.25 Present value -500000.00 200000.00 170888.47 146494.62 125922.93 108479.99 93622.10 80917.77 70020.50 60648.93 52572.32 Sume of present value 609567.63

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