The Platinum Company is a national mattress manufacturer. Its Marion plant will become idle on December 31, 2020. Nina Simon, the corporate controller, has been asked to look at three options regarding the plant: Option 1: The plant can be leased to the Coil Corporation, one of Platinum's suppliers, for 3 years. Under the lease terms, Coil would pay Platinum $220,000 rent per year (payable at year-end) and would grant Platinum a $64,000 annual discount from the normal price of coils purchased by Platinum. (Assume that the discount is received at year-end for each of the 3 years.) Coil would bear all of the plant's ownership costs. expects to sell this plant for $320,000 at the end of the 3-year lease. Option 2: The plant could be used for 3 years to make mattress covers as an accessory to be sold with a mattress. Fixed overhead costs (a cash outflow) before any equipment upgrades are estimated to be $18,000 annually for the 3-year period (assume the fixed costs occur at year-end). The covers are expected to sell for $25 each and variable cost per unit is expected to be $10. The following production and sales of the mattress covers are expected: 2021, 22,000 units; 2022, 18,000 units; 2023 ,20,000 units. In order to manufacture the mattress covers, some of the plant equipment would need to be upgraded at an immediate cost of $120,000. The equipment would be depreciated using the straight-line depreciation method and zero terminal disposal value over the 3 years it would be in use. Because of the equipment upgrades, Platinum could sell the plant for $360,000 at the end of 3 years. No change in working capital would be required. Option 3: The plant, which has been fully depreciated for tax purposes, can be sold immediately for $800,000 . The Platinum 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%. is subject to a 25% tax rate on all income, including capital gains. Requirements: . Calculate net present value of each of the options and determine which option Platinum should select using the NPV criterion. 2. What nonfinancial factors should Platinum consider before making its choice?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
The Platinum Company is a national mattress manufacturer. Its Marion plant will become idle on December 31, 2020. Nina Simon, the corporate controller, has been asked to look at three options regarding the plant:
Option 1:
The plant can be leased to the Coil Corporation, one of Platinum's suppliers, for 3 years. Under the lease terms, Coil would pay Platinum $220,000 rent per year (payable at year-end) and would grant Platinum a $64,000 annual discount from the normal price of coils purchased by Platinum. (Assume that the discount is received at year-end for each of the 3 years.) Coil would bear all of the plant's ownership costs. expects to sell this plant for $320,000 at the end of the 3-year lease.
Option 2:
The plant could be used for 3 years to make mattress covers as an accessory to be sold with a mattress. Fixed overhead costs (a cash outflow) before any equipment upgrades are estimated to be $18,000 annually for the 3-year period (assume the fixed costs occur at year-end). The covers are expected to sell for $25 each and variable cost per unit is expected to be $10. The following production and sales of the mattress covers are expected: 2021, 22,000 units; 2022, 18,000 units; 2023 ,20,000 units. In order to manufacture the mattress covers, some of the plant equipment would need to be upgraded at an immediate cost of $120,000. The equipment would be
Option 3:
The plant, which has been fully depreciated for tax purposes, can be sold immediately for $800,000 .
The Platinum Company treats all cash flows as if they occur at the end of the year, and uses an after-tax required
Calculate
2.
What nonfinancial factors should Platinum consider before making its choice?
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