Question

A company is considering building a new and improved production facility for one of its existing

products. It would be built on a piece of vacant land that the firm owns. This land was acquired

four years ago at a cost of $500,000; it has a current market value of $800,000. The building can

be erected for $600,000. Machinery (equipment) worth $120,000 needs to be bought. The

company will finance the construction of the building and the purchase of the equipment by

borrowing $720,000 for 10 years at 10% interest. Interest will be paid annually and the full

amount of the loan will be repaid in one payment at the end of the 10 years. The company’s net

working capital will increase by $100,000 if the new production facility is built. Operating savings

from the new production facility are expected to be $300,000 per year for the next 10 years. The

total fair market value (salvage value) of the assets at the end of the 10 years is expected to be

$1,000,000− one quarter of which is attributable to the building and equipment. The building and

equipment will be amortized on a straight-line basis over 10 years. The firm’s tax rate is 40

percent and CCA will be taken on all depreciable assets at a rate of 20%. The firm’s weighted

average cost of capital (WACC) is estimated at 15 percent. Should the company build the new

and improved production facility? Round final dollar amounts (in each category) to closest

dollar (i.e., ignore cents).

[NOTE: Although not realistic, the question assumes that the construction of the building will be

completed “immediately”. Thus, the operating savings are realized starting Year 1.]

Answer 1

Answer

Based on the above-provided information it can be interpreted that the new and improved production facility will be a mere success. The reason behind that is based on the financial strategy of the net working capital of the new production facility may increase. The fair market value along with that the goodwill will also increase simultaneously. This is wholly dependent on the management techniques and strategy which are adopted in that case. Based on the amortization rate which is 10%, in this case, the value of the intangible assets of the newly constructed building and equipment will increase consistently. In this case, maximum production is the ultimate thing that is quite necessary to enhance the overall financial matter of the business. The effective working capital management system of the company will ensure timely payment of interest rates regarding loan financing. This is quite the facts and figures which are enumerated in the above discussion behind the success of the new and improved production facility.