Question

ABC Manufacturing expects to sell 1,025 units of product in 2021 at an average price of $100,000 each based on current demand.
The Chief Marketing Officer forecasts growth of 50 units per year through 2025. So, the demand will be 1,025 units in 2021, 1,075 units
in 2022, etc. and the $100,000 price will remain consistent for all five years of the investment life. However, ABC cannot produce more
than 1,000 units annually based on current capacity.
In order to meet demand, ABC must either update the current plant or replace it. If the plant is replaced, an initial working capital investment
of $5,000,000 is required and these funds will be released at the end of the investment life to be used elsewhere.
The following table summarizes the projected data for both options:
						Update		Replace
Initial investment in 2021						$    115,000,000		$    138,000,000
Terminal salvage value in 2025						$      10,000,000		$                     -
Working capital investment required						$                     -		$        5,000,000
Useful life						5 years		5 years
Total annual cash operating costs per unit						$             70,000		$             60,000

Which option is better and why?

Answer 1