Question

The Ralling 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: (Click the icon to view the options.) Present Value of $1 table Present Value of Annuity of $1 table Future Value of $1 table Future Value of Annuity of $1 table Read the requirements, Ralling 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 10%. Ralling is subject to a 30% tax rate on all income, including capital gains. Requirement 1. Calculate net present value of each of the options and determine which option Ralling should select using the NPV criterion The net present value of Option 1 i More Info Begin the calculation of Option 2 byl Finally, determine the after-tax cash use a minus sign or parentheses for material purchases discount hree decimal places, X.XXX, and Jarest whole dollar) Present value of net cash flows, og After-tax cash inflows from rent: Dec 31, 2018 Dec 31, 2019 Dec 31, 2020 Dec 31, 2021 Option 1: The plant, which has been fully depreciated for tax purposes, can be sold immediately for $710,000. Option 2: The plant can be leased to the Timber Corporation, one of Ralling's suppliers, for 4 years. Under the lease terms, Timber would pay Ralling $171,000 rent per year (payable at year-end) and would grant Ralling a $58,000 annual discount from the normal price of lumber purchased by Raling. 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. Ralling expects to sell this plant for $300,000 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 $21,000 annually for the 4-year period. The swings are expected to sell for $48 each. Variable cost per unit is expected to be $20. The following production and sales of swings are expected: 2018, 13,000 units: 2019, 19,000 units: 2020, 15,000 units: 2021, 12,000 units. In order to manufacture the swings, some of the plant equipment would need to be upgraded at an immediate cost of $250,000. 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, Ralling could sell the plant for $310,000 at the end of 4 years. No change in working capital would be required. Print Done

Answer 1

Answer with working is given below

Option 1 Selling price of plant Tax at 30% Net cash inflow $710,000 $213,000 $497,000 Option 2 Year 1 $171,000 $58,000 Year 2 $171,000 $58,000 Year 3 $171,000 $58,000 Lease rentals Annual discount Sale value of plant Total Income Tax at 30% Net cash inflow PV factor at 10% PV of cash inflow Total $684,000 $232,000 $300,000 $1,216,000 $364,800 $851,200 $229,000 $68,700 $160,300 0.9091 $145,727 $229,000 $68,700 $160,300 0.82641 $132,479 Year 4 $171,000 $58,000 $300,000 $529,000 $158,700 $370,300 0.6830 $252,920 $229,000 $68,700 $160,300 $120,436 $651,562 Option 3 2019 2021 Total $48 $48 2018 $48 $20 $28 13,000 $364,000 $20 $28 19,000 $532,000 2020 $48 $20 $28 15,000 $420,000 $20 $28 12,000 $336,000 $1,652,000 $21,000 $62,500 $21,000 $62,500 $21,000 $62,500 $21,000 $62,500 $84,000 $250,000 Selling price Variable cost Contribution Units Total Contribution Less Fixed Cost Depreciation Add Sale value of Plant Taxable income Tax at 30% Net income after tax Add: Depreciation Annual cash inflow PV factor at 10% PV of cash inflow Less: Immediate cost Net Present Value $280,500 $84,150 $196,350 $62,500 $258,850 0.9091 $235,318 $448,500 $134,550 $313,950 $62,500 $376,450 0.8264 $311,116 $336,500 $100,950 $235,550 $62,500 $298,050 0.7513 $223,929 $310,000 $562,500 $168,750 $393,750 $62,5001 $456,250 0.6830 $311,625 $310,000 $1,628,000 $488,400 $1,139,600 $250,000 $1,389,600 $1,081,988 $250,000 $831,988 Since Net present value under Option 3 is higher Option 3 should be considered