Question

Adhesion Inc. is currently evaluating an expansion plan for its operations using an eight-year planning horizon. If the plan is accepted, then a new plant will be built at a cost of $2,500,000 on a vacant lot owned by Adhesion. The land originally cost Adhesion $400,000, although its current market value is $750,000. The expansion plan also requires the purchase of a new machine at a cost of $800,000. This new machine has an annual production capacity of 160,000 units. Installation of the machine will cost an additional $50,000. Finally, an investment of $100,000 in working capital will be required for the operation of the new plant. Based on its current business, management believes that there is market demand for an additional 200,000 units of its product annually at the current price of $15 per unit. Direct costs of production are estimated to be $8 per unit. Management also intends to allocate $250,000 of corporate (head office) overhead to the new plant. At the end of the eight-year planning horizon, salvage on the building is estimated to be 25% of its original cost, the salvage value of the machine is estimated at $85,000 and the anticipated market value for the land is $900,000. If Adhesion’s marginal tax rate is 32%, its cost of capital is 14% and the CCA rates on the building and the machine are 7.5% and 15%, respectively, then should Adhesion implement the expansion plan? How many minimum units must Adhesion produce and sell in order for the plan to be worthwhile?

Answer 1

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Calcul&tion umits for profir Proft

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