Houma Bio-Control has hired you as a consultant to assess the economic feasibili
ID: 2705304 • Letter: H
Question
Houma Bio-Control has hired you as a consultant to assess the economic feasibility of investing $2,500,000 to purchase a fully operational toad ranch. The ranch is currently capable of raising and bringing to market 5,000,000 toads per year. The toads will be marketed and sold as environmentally safe insect control mechanisms at $240 per 1000(toads). Due to a worldwide shortage of toads and increasing concern over the environmental damage caused by pesticides, theprice of toads is expected to increase at 6% per year for centuries to come. The cost of labor, which will be $1,000,000 next year, is expected to continue to increase in perpeuity at a rate of 5% per year. The apparatus that is used to aerate the lagoon in which the toads reside must be replaced immediately. The current cost to replace the aerator is $500,000. Although aerators do not qualify for any investment tax credit, the aerator can be depreciated to a zero salvage value over a 4 year period using straight-line depreciation. An industrial engineer hired by HBC estimates that the aerator must be replaced every five years. The cost of aerators is expected to increase at 4 percent per year far into the foreseeable future. Assuming that HBC has an opportunity cost of capital of 10% percent and a corporate tax rate of 40%, determine whether the firm should acquire the toad ranch.
Explanation / Answer
Price of toad ranch=$2500000
Production capacity per year=5000000
So net income for the first year= 5000000*240/1000=$1200000
Labor cost=$1000000
Aerator=$500000
Tax @ 40 %= 1200000*0.4=$480000
Cost of capital= 1200000*0.1=120000
So ,
Total income= 1200000-(1000000+500000+480000+120000)
=-900000
As total income is negative that means there is loss in acquiring the toad ranch since the factors turned it not feasible and hence firm should not acquire the toad ranch.
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