In: Finance
Benson Enterprises is evaluating alternative uses for a
three-story manufacturing and warehousing building that it has
purchased for $1,520,000. The company can continue to rent the
building to the present occupants for $68,000 per year. The present
occupants have indicated an interest in staying in the building for
at least another 15 years. Alternatively, the company could modify
the existing structure to use for its own manufacturing and
warehousing needs. Benson’s production engineer feels the building
could be adapted to handle one of two new product lines. The cost
and revenue data for the two product alternatives are as
follows:
Product A | Product B | |||
Initial cash outlay for building modifications | $ | 102,000 | $ | 132,000 |
Initial cash outlay for equipment | 202,000 | 237,000 | ||
Annual pretax cash revenues (generated for 15 years) | 192,000 | 229,000 | ||
Annual pretax expenditures (generated for 15 years) | 77,000 | 97,000 | ||
The building will be used for only 15 years for either Product A or
Product B. After 15 years the building will be too small for
efficient production of either product line. At that time, Benson
plans to rent the building to firms similar to the current
occupants. To rent the building again, Benson will need to restore
the building to its present layout. The estimated cash cost of
restoring the building if Product A has been undertaken is $62,000.
If Product B has been manufactured, the cash cost will be $87,000.
These cash costs can be deducted for tax purposes in the year the
expenditures occur.
Benson will depreciate the original building shell over a 30-year
life to zero, regardless of which alternative it chooses. The
building modifications and equipment purchases for either product
are estimated to have a 15-year life. They will be depreciated by
the straight-line method. The firm’s tax rate is 38 percent, and
its required rate of return on such investments is 13
percent.
Assume all cash flows occur at the end of the year. The initial
outlays for modifications and equipment will occur today (Year 0),
and the restoration outlays will occur at the end of Year 15.
What is the NPV of the decision to continue to
rent? (Do not round intermediate calculations and round
your answer to 2 decimal places, e.g., 32.16.)
NPV $
What is the NPV for modifying the building to manufacture
Product A? (Do not round intermediate calculations and
round your answer to 2 decimal places, e.g., 32.16.)
NPV $
What is the NPV for modifying the building to manufacture
Product B? (Do not round intermediate
calculations and round your answer to 2 decimal places, e.g.,
32.16.)
NPV $