Payback, Net Present Value, Internal Rate of Return, Effects ofDifferences in Sales on Project ViabilityShaftel Ready Mix is a processor and supplier of concrete, aggregate, and rock products. Thecompany operates in the intermountain western United States. Currently, Shaftel has 14 cement-processing plants and a labor force of more than 375 employees. With the exception ofcement powder, all materials (e.g., aggregates and sand) are produced internally by the company.The demand for concrete and aggregates has been growing steadily nationally. In the West, thegrowth rate has been above the national average. Because of this growth, Shaftel has more thantripled its gross revenues over the past 10 years.Of the intermountain states, Arizona has been experiencing the most growth. Processingplants have been added over the past several years, and the company is considering the addition of yet another plant to be located in Scottsdale. A major advantage of another plant inArizona is the ability to operate year round, a feature not found in states such as Utah andWyoming. In setting up the new plant, land would have to be purchased and a small building constructed. Equipment and furniture would not need to be purchased. These items would betransferred from a plant that opened in Wyoming during the oil boom period and closed a fewyears after the end of that boom. However, the equipment needs some repair and modificationsbefore it can be used. The equipment has a book value of $200,000, and the furniture has a bookvalue of $30,000. Neither has any outside market value. Other costs, such as the installationof a silo, well, electrical hookups, and so on, will be incurred. No salvage value is expected. Thesummary of the initial investment costs by category is as follows:Land $ 20,000Building 135,000Equipment:Book value 200,000Modifications 20,000Furniture (book value) 30,000Silo 20,000Well 80,000Electrical hookups 27,000General setup 50,000Total $582,000Estimates concerning the operation of the Scottsdale plant follow:Life of plant and equipment 10 yearsExpected annual sales (in cubic yards of cement) 35,000Selling price (per cubic yard of cement) $45.00Variable costs (per cubic yard of cement):Cement $ 12.94Sand/gravel 6.42Fly ash 1.13Admixture 1.53Driver labor 3.24Mechanics 1.43Plant operations (batching and cleanup) 1.39Loader operator 0.50Truck parts 1.75Fuel 1.48Other 3.27Total variable costs $ 35.08Fixed costs (annual):Salaries $135,000Insurance 75,000Telephone 5,000Depreciation 58,200*Utilities 25,000Total fixed costs $298,200*Straight-line depreciation is calculated by using all initial investmentcosts over a 10-year period, assuming no salvage value.After reviewing these data, Karl Flemming, vice president of operations, argued against the proposed plant. Karl was concerned because the plant would earn significantly less than the normal8.3% return on sales. All other plants in the company were earning between 7.5 and 8.5% onsales. Karl also noted that it would take more than 5 years to recover the total initial outlay of $582,000. In the past, the company had always insisted that payback be no more than 4 years.The company’s cost of capital is 10%. Assume that there are no income taxes.Required:1. Prepare a variable-costing income statement for the proposed plant. Compute the ratio ofnet income to sales. Is Karl correct that the return on sales is significantly lower than thecompany average?2. Compute the payback period for the proposed plant. Is Karl right that the paybackperiod is greater than 4 years? Explain. Suppose you were told that the equipment beingtransferred from Wyoming could be sold for its book value. Would this affect youranswer?3. Compute the NPV and the IRR for the proposed plant. Would your answer be affected ifyou were told that the furniture and equipment could be sold for their book values? If so,repeat the analysis with this effect considered.4. Compute the cubic yards of cement that must be sold for the new plant to break even.Using this break-even volume, compute the NPV and the IRR. Would the investment beacceptable? If so, explain why an investment that promises to do nothing more than breakeven can be viewed as acceptable.5. Compute the volume of cement that must be sold for the IRR to equal the firm’s cost ofcapital. Using this volume, compute the firm’s expected annual income. Explain this result.
Payback,
Differences in Sales on Project Viability
Shaftel Ready Mix is a processor and supplier of concrete, aggregate, and rock products. The
company operates in the intermountain western United States. Currently, Shaftel has 14 cement-processing plants and a labor force of more than 375 employees. With the exception of
cement powder, all materials (e.g., aggregates and sand) are produced internally by the company.
The demand for concrete and aggregates has been growing steadily nationally. In the West, the
growth rate has been above the national average. Because of this growth, Shaftel has more than
tripled its gross revenues over the past 10 years.
Of the intermountain states, Arizona has been experiencing the most growth. Processing
plants have been added over the past several years, and the company is considering the addition of yet another plant to be located in Scottsdale. A major advantage of another plant in
Arizona is the ability to operate year round, a feature not found in states such as Utah and
Wyoming.
In setting up the new plant, land would have to be purchased and a small building constructed. Equipment and furniture would not need to be purchased. These items would be
transferred from a plant that opened in Wyoming during the oil boom period and closed a few
years after the end of that boom. However, the equipment needs some repair and modifications
before it can be used. The equipment has a book value of $200,000, and the furniture has a book
value of $30,000. Neither has any outside market value. Other costs, such as the installation
of a silo, well, electrical hookups, and so on, will be incurred. No salvage value is expected. The
summary of the initial investment costs by category is as follows:
Land $ 20,000
Building 135,000
Equipment:
Book value 200,000
Modifications 20,000
Furniture (book value) 30,000
Silo 20,000
Well 80,000
Electrical hookups 27,000
General setup 50,000
Total $582,000
Estimates concerning the operation of the Scottsdale plant follow:
Life of plant and equipment 10 years
Expected annual sales (in cubic yards of cement) 35,000
Selling price (per cubic yard of cement) $45.00
Variable costs (per cubic yard of cement):
Cement $ 12.94
Sand/gravel 6.42
Fly ash 1.13
Admixture 1.53
Driver labor 3.24
Mechanics 1.43
Plant operations (batching and cleanup) 1.39
Loader operator 0.50
Truck parts 1.75
Fuel 1.48
Other 3.27
Total variable costs $ 35.08
Fixed costs (annual):
Salaries $135,000
Insurance 75,000
Telephone 5,000
Depreciation 58,200*
Utilities 25,000
Total fixed costs $298,200
*Straight-line depreciation is calculated by using all initial investment
costs over a 10-year period, assuming no salvage value.
After reviewing these data, Karl Flemming, vice president of operations, argued against the proposed plant. Karl was concerned because the plant would earn significantly less than the normal
8.3% return on sales. All other plants in the company were earning between 7.5 and 8.5% on
sales. Karl also noted that it would take more than 5 years to recover the total initial outlay of $582,000. In the past, the company had always insisted that payback be no more than 4 years.
The company’s cost of capital is 10%. Assume that there are no income taxes.
Required:
1. Prepare a variable-costing income statement for the proposed plant. Compute the ratio of
net income to sales. Is Karl correct that the return on sales is significantly lower than the
company average?
2. Compute the payback period for the proposed plant. Is Karl right that the payback
period is greater than 4 years? Explain. Suppose you were told that the equipment being
transferred from Wyoming could be sold for its book value. Would this affect your
answer?
3. Compute the NPV and the IRR for the proposed plant. Would your answer be affected if
you were told that the furniture and equipment could be sold for their book values? If so,
repeat the analysis with this effect considered.
4. Compute the cubic yards of cement that must be sold for the new plant to break even.
Using this break-even volume, compute the NPV and the IRR. Would the investment be
acceptable? If so, explain why an investment that promises to do nothing more than break
even can be viewed as acceptable.
5. Compute the volume of cement that must be sold for the IRR to equal the firm’s cost of
capital. Using this volume, compute the firm’s expected annual income. Explain this result.
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