Sun Industries is considering the expansion of its operation by extending its plant.
The new plant, with a life of 10 years, will cost $1,500,000 to build on existing land
owned by Sun. The plant will have zero scrap value. The land has an estimated
market value of $750,000. Additional spare parts of $150,000 and additional
inventory of $600,000 will be required to support the new operation.
The annual revenue and expenses associated with the project are estimated to be as
follows:
Revenue $2,250,000
Operating Expenses $1,450,000
Increased Overhead Expense $150,000
Increased Head Office Expense $180,000
Allowable depreciation $150,000
The after tax weighted average required rate of return appropriate to the project is
13% and the corporate tax rate is 30%.
Required:
Evaluate the project for Sun Industries
Year 0 1-9 10
STEP 1 – Calculate Taxable Income
Increased Revenues 2,250,000 2,250,000
Costs -1,780,000 -1,780,000
Depreciation -150,000 -150,000
Gain/Loss on Sale of land of building
Taxable income 0 320,000 320,000
Tax @ 30% 0 -96,000 -96,000
STEP 2 – Include All Cash Flows
Tax refund/paid 0 -96,000 -96,000
Initial Cost (Land for opportunity cost +
Building) -2,250,000
Increased Revenues 2,250,000 2,250,000
Costs -1,780,000 -1,780,000
Working Capital -750,000 750,000
Salvage value of land and building
Net Cash Flow -3,000,000 374,000 1,124,000
NPV ($749,644)
IRR 7.05%