Question

Krasner Corporation is a diversified company with several manufacturing plants. Krasner’s

Houston Plant has been supplying parts to truck manufacturers for over 20 years. The last

shipment of truck parts from the Houston Plant will be made on December 31, 2018. Krasner’s

management is currently evaluating three alternatives relating to its soon-to-be-idle plant and

equipment in Houston.

Pufong Industries has offered to buy the Houston Plant for $3,000,000 cash on January 7, 2019.

Barreau Enterprises has offered to lease the Houston facilities for 4 years beginning on January 1, 2019. Barreau’s annual lease payments would be $500,000 plus 10%

of the gross dollar sales of all items produced in the Houston Plant. Probabilities of

Barreau’s annual gross dollar sales from the Houston Plant are estimated as follows:

                Annual Gross Dollar Sales                  Estimated Probability

                            $2,000,000                                                .1

                              4,000,000                                                .4

                              6,000,000                                                .3

                              8,000,000                                                .2

Krasner is considering the production of souvenir items to be sold in connection

with upcoming sporting events. The Houston Plant will be used to produce 70,000

items per month at an annual cash outlay of $2,250,000 during 2019, 2020, and 2021.

Ashley Payne, Vice President of Marketing, has recommended a selling price of $5

per item and believes the items will sell uniformly throughout 2019, 2020, and 2021.

The adjusted basis of the Houston Plant as of the close of business on December 31, 2018 will be $4,200,000. Krasner has used straight-line depreciation for all capital

Assets at the Houston Plant. If the Houston Plant is not sold, the annual straight-line

Depreciation expense for the plant and equipment will be $900,000 for the next 4 years. The market value of the plant and equipment on December 3, 2021 is estimated to be $600,000.

Krasner requires an after-tax rate of return of 16% for capital investment decisions

and is subject to a corporate tax rate of 40% on all income.

Calculate the present value at December 31, 2021 of the expected after-tax cash flows for each of the three alternatives available to Krasner Corporation regarding the Houston Plant. Assume all recurring cash flows take place at the end of the year.

Discuss the additional factors, both quantitative and qualitative, Krasner Corporation should consider before a decision is made regarding the disposition or use of the idle plant and equipment at the Houston plant

This question was answered but please can you show me the workings, how the Present value was gotten?

Thanks

Answer 1

Alternative 1
Pufong Industries' offer to buy
After-tax cash inflow
3000000*(1-40%)=
1800000

Alternative 2
Barreau Enterprises lease offer
PV of 4 end- of- year Lease payments
End Year	Fixed amount	After-Tax sales $ (Gross sales*(1-40%)	Probabilty	Probable sales(AT Sales*prob.)	10%*prob. Sales	Fixed amt.+10%*Prob.sales	PV F at 16%	PV at 16%
1	500000	1200000	0.1	120000	12000	512000	0.86207	441379
2	500000	2400000	0.4	960000	96000	596000	0.74316	442925
3	500000	3600000	0.3	1080000	108000	608000	0.64066	389520
4	500000	4800000	0.2	960000	96000	596000	0.55229	329165
Total PV of 4 end -of -year Lease payments								1602990

Alternative 3
Production of souvenir items in Houston plant
	Year 0	Yr 1(2019)	Yr.2(2020)	Yr.3(2020)	Yr.4(2021)
Annual cash outlay		-2250000	-2250000	-2250000
Sales cash inflows(70000*12mths.* $ 5)		4200000	4200000	4200000
Less: Depreciation (4200000/3)		-1400000	-1400000	-1400000
EBT		550000	550000	550000
Less:Tax at 40%*EBT		-220000	-220000	-220000
EAT		330000	330000	330000
Add Back depn.		1400000	1400000	1400000
Operating cash flows		1730000	1730000	1730000
Less: Depn. Tax shield lost(900000*40%)		-360000	-360000	-360000	-360000
Add: After-tax salvage(600000*(1-40%)					360000
NET annual cash flows	0	1370000	1370000	1370000	0
PV F at 16%	1	0.86207	0.74316	0.64066	0.55229
PV at 16%	0	1181034	1018133	877701	0
NPV as at Jan 1, 2019	3076869
As the third alternative,ie. To produce sovenir items utilising the idle capacity at the Houston plant fetches the highest NPV ($ 3076869) , the same is recommended.
Qualitatively, also, it is a better option as that will not be displacing any of the existing workforce .
Also, the market can be explored with the new production , with the existing plant , without having to spend any additional amounts on capital outlay.