Question:
Looner Industries is considering investing in a new manufacturing plant. The plant requires an item of equipment that costs $200,000. In addition, Looner will spend $10,000 on shipping costs and $30,000 on installation charges. The equipment will be housed in a building currently owned by the company. The building was bought at a cost of $75,000 five years ago, but it could be sold now for $125,000. Similar buildings in the area are leasing for $5,000 per month.
You estimate that if the new plant is constructed, the company will increase its inventories by $25,000, while accounts payable also will rise by $5,000. New sales from the plant are estimated to be 120,000 units per year, at a price of $3.50 per unit. Variable costs are expected to total 60% of sales, while fixed costs are estimated at $20,000 per year. The plant has an estimated economic life of 4 years, after which time it will be scrapped for $25,000 (excluding the building). Depreciation will be calculated using the 3-year MACRS rates of 33%, 45%, 15%, and 7% for the first through the fourth year, respectively. Looner Industries' marginal tax rate is 40%, and its cost of capital is 10%. Should the plant be built?