Chapter 21, Problem 21.33E

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:

• 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. 1. Calculate net present value of each of the options and determine which option Cook should select using the NPV criterion.

   Required

2. 2. What nonfinancial factors should Cook consider before making its choice?