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

Answer 1

Option 1	Buy		After-Tax		Present Value
	30,00,000.00		18,00,000.00		28,09,612.80
Option 2	Lease
	20,00,000.00	0.1	2,00,000.00
	40,00,000.00	0.4	16,00,000.00
	60,00,000.00	0.3	18,00,000.00
	80,00,000.00	0.2	16,00,000.00
	Expected Sales		52,00,000.00
	Lease % share	0.1	5,20,000.00
	Fixed Share		5,00,000.00
	Before Tax		10,20,000.00
	Less : Tax		-4,08,000.00
	After Tax		6,12,000.00
			Profit		Present Value
			6,12,000.00	2019	8,23,507.20
			6,12,000.00	2020	7,09,920.00
			6,12,000.00	2021	6,12,000.00
					21,45,427.20
Option 3	Continue
	Units per year		8,40,000.00
	Price		5.00
	Sales Value		42,00,000.00
	(-) Cash Outlay		-22,50,000.00
			19,50,000.00
	(-) Depreciation		-9,00,000.00
	Profit before Tax		10,50,000.00
	Less : Tax		-4,20,000.00
	Profit After Tax		6,30,000.00
			Profit		Present Value
			6,30,000.00	2019	8,47,728.00
			6,30,000.00	2020	7,30,800.00
	Profit + Value of plant after tax		9,90,000.00	2021	9,90,000.00
					25,68,528.00
	Assumption : Receipt on sale of plant is fully taxable. Krasner Corporation should consider the following factors before making decision regarding the disposition or use of the idle plant and equipment at the Houston plant : Accuracy of the cash flow estimates and discounting factor and timings of cash flow.