• Option 1: The plant, which has been fully depreciated for tax purposes, can be sold immediately for $750,000. Option 2: The plant can be leased to the Timber Corporation, one of Cook's suppliers, for 4 years. Under the lease terms, Timber would pay Cook $175,000 rent per year (payable at year-end) and would grant Cook a $60,000 annual discount from the normal price of lumber purchased by Cook. (Assume that the discount is received at year-end for each of the 4 years.) Timber would bear all of the plant's ownership costs. Cook expects to sell this plant for $250,000 at the end of the 4-year lease. • Option 3: The plant could be used for 4 years to make porch swings as an accessory to be sold with a portable building. Fixed overhead costs (a cash outflow) before any equipment upgrades are estimated to be $22,000 annually for the 4-year period. The swings are expected to sell for $45 each. Variable cost per unit is expected to be $22. The following production and sales of swings are expected: 2018, 12,000 units; 2019, 18,000 units; 2020, 15,000 units; 2021, 8,000 units. In order to manufacture the swings, some of the plant equipment would need to be upgraded at an immediate cost of $180,000. The equipment would be depreciated using the straight-line depreciation method and zero terminal disposal value over the 4 years it would be in use. Because of the equipment upgrades, Cook could sell the plant for $320,000 at the end of 4 years. No change in working capital would be required. Cook Company treats all cash flows as if they occur at the end of the year, and uses an after-tax required rate of return of 8%. Cook is subject to a 30% tax rate on all income, including capital gains. 1. Calculate net present value of each of the options and determine which option Cook should select us- ing the NPV criterion. 2. What nonfinancial factors should Cook consider before making its choice? Required
• Option 1: The plant, which has been fully depreciated for tax purposes, can be sold immediately for $750,000. Option 2: The plant can be leased to the Timber Corporation, one of Cook's suppliers, for 4 years. Under the lease terms, Timber would pay Cook $175,000 rent per year (payable at year-end) and would grant Cook a $60,000 annual discount from the normal price of lumber purchased by Cook. (Assume that the discount is received at year-end for each of the 4 years.) Timber would bear all of the plant's ownership costs. Cook expects to sell this plant for $250,000 at the end of the 4-year lease. • Option 3: The plant could be used for 4 years to make porch swings as an accessory to be sold with a portable building. Fixed overhead costs (a cash outflow) before any equipment upgrades are estimated to be $22,000 annually for the 4-year period. The swings are expected to sell for $45 each. Variable cost per unit is expected to be $22. The following production and sales of swings are expected: 2018, 12,000 units; 2019, 18,000 units; 2020, 15,000 units; 2021, 8,000 units. In order to manufacture the swings, some of the plant equipment would need to be upgraded at an immediate cost of $180,000. The equipment would be depreciated using the straight-line depreciation method and zero terminal disposal value over the 4 years it would be in use. Because of the equipment upgrades, Cook could sell the plant for $320,000 at the end of 4 years. No change in working capital would be required. Cook Company treats all cash flows as if they occur at the end of the year, and uses an after-tax required rate of return of 8%. Cook is subject to a 30% tax rate on all income, including capital gains. 1. Calculate net present value of each of the options and determine which option Cook should select us- ing the NPV criterion. 2. What nonfinancial factors should Cook consider before making its choice? Required
Financial Management: Theory & Practice
16th Edition
ISBN:9781337909730
Author:Brigham
Publisher:Brigham
Chapter19: Lease Financing
Section: Chapter Questions
Problem 6P: Big Sky Mining Company must install 1.5 million of new machinery in its Nevada mine. It can obtain a...
Related questions
Question
Selling a plant, income taxes. (CMA, adapted) The Cook Company is a national portable building manufacturer. Its Benton plant will become idle on December 31, 2017. Mary Carter, the corporate controller, has been asked to look at three options regarding the plant:
Transcribed Image Text:• Option 1: The plant, which has been fully depreciated for tax purposes, can be sold immediately for
$750,000.
Option 2: The plant can be leased to the Timber Corporation, one of Cook's suppliers, for 4 years. Under
the lease terms, Timber would pay Cook $175,000 rent per year (payable at year-end) and would grant
Cook a $60,000 annual discount from the normal price of lumber purchased by Cook. (Assume that the
discount is received at year-end for each of the 4 years.) Timber would bear all of the plant's ownership
costs. Cook expects to sell this plant for $250,000 at the end of the 4-year lease.
• Option 3: The plant could be used for 4 years to make porch swings as an accessory to be sold with a
portable building. Fixed overhead costs (a cash outflow) before any equipment upgrades are estimated
to be $22,000 annually for the 4-year period. The swings are expected to sell for $45 each. Variable cost
per unit is expected to be $22. The following production and sales of swings are expected: 2018, 12,000
units; 2019, 18,000 units; 2020, 15,000 units; 2021, 8,000 units. In order to manufacture the swings, some
of the plant equipment would need to be upgraded at an immediate cost of $180,000. The equipment
would be depreciated using the straight-line depreciation method and zero terminal disposal value
over the 4 years it would be in use. Because of the equipment upgrades, Cook could sell the plant for
$320,000 at the end of 4 years. No change in working capital would be required.
Cook Company treats all cash flows as if they occur at the end of the year, and uses an after-tax required
rate of return of 8%. Cook is subject to a 30% tax rate on all income, including capital gains.
1. Calculate net present value of each of the options and determine which option Cook should select us-
ing the NPV criterion.
2. What nonfinancial factors should Cook consider before making its choice?
Required
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 7 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, accounting and related others by exploring similar questions and additional content below.Recommended textbooks for you