At this point, PP's bottled water business has shown operating losses of nearly $300(000), which does not include the initial investment of more than $800(000). Management is now taking a critical look at the decision made nearly three years ago and must decide between one of four options. It can (1) continue as is; (2) abandon the project completely; (3) stop producing bottled water but retain ownership of the land and lease the building; or (4) go after the bottled water market by acquiring Well Water. The "as is" alternative does not require any additional expenditure and is expected to generate the situation shown in Exhibit 1. No one finds this option especially appealing. Management's thinking is, "If we stay in the market, let's do it right or give the project its pink slip."
Pro Forma "As Is" Income Statement for Punch Product's Bottled Water Division
(000s)*
|
|
|
Sales
Cost of goods sold
Gross margin
General administrative expenses
Selling expenses
Miscellaneous fixed expenses
Depreciation expense
EBIT
Taxes (40%)
Net income
|
$ 800
200
600
150
290
10
100
50
20
$ 30
|
|
*Management feels this situation could persist indefinitely
Abandoning the project has at least one vocal supporter, Clifton Millard, a plant manager, who argues that this strategy will give PP immediate benefit. The land that PP paid $200(000) for ten years ago has a market value of $380(000) and is not presently needed. The factory would, of course, be sold with the land and is worth about $90(000). He admits that the trucks PP purchased have relatively little market value since they are highly specialized; that is, they were built to carry the 5-gallon jars of water and are not especially suitable for other purposes. A reasonable estimate is that they could be sold for 50 percent of their book value. The remaining equipment can also be sold at 50 percent of book. The receivables are generally of good quality and PP should obtain $72(000) when they are collected. "And, of course," notes Millard, "we could liquidate at 100 percent of book, our inventory of bottled water."
Stan Covington, the firm's president, also favors abandoning the project, though his proposal is not quite as drastic Millard's. He suggests keeping the land and renting the building, though the trucks and equipment would be sold, the receivables collected, and the inventory liquidated. Leasing the building would be a simple matter and would net $40(000) a year; a figure that includes all yearly expenses but not taxes. He agrees with Millard that the land is not needed by PP now, but in three to five years it might be since PP's soft drink sales have been growing and it is very likely that the firm will need additional area for expansion. The location of the current bottled water plant is considered ideal for growth. "At a minimum," argues Covington, "if we keep the land it can always be sold in the future. The current market value is nearly 100 percent more than we paid for it and should continue to appreciate this way." He also points out that the factories could be used for the production of soft drinks.