Question: The Commonwealth Ice Cream Company manufactures and distributes ice cream in the state of Virginia. At the present time the company owns four ice cream plants located at Alexandria, Norfolk, Roanoke, and Richmond. These plants are used to manufacture and distribute ice cream throughout the state on a daily basis. Due to the high rate of population growth in the Washington, D.C. area, the company is considering building a new plant at Arlington, Virginia. If the new plant is built, one or more of the existing plants would be phased out, depending on the economics of the situation and future demand levels.
While each plant currently distribute to its own marketing area, this practice is not required. Any plant can distribute ice cream to any marketing area in the state. The capacity of each plant and the costs of production are shown in Exhibit 2. As indicated, the costs of production vary from one location to another due to different labor costs, different cost of materials and different plant efficiencies. If the new plant is built in Arlington, it will have a capacity of 1200cwt (hundredweight, or 100 pounds) per day and a cost of production of $21 per cwt.
Exhibit 2:
| Plant |
Plant Capacity cwt per day |
Production cost per cwt |
| Alexandria |
1000 |
$25 |
| Richmond |
800 |
23 |
| Norfolk |
800 |
21 |
| Roanoke |
500 |
22 |
Total= 3100
The current distribution plan is shown in Exhibit 3, along with the projected market demand for the next 5 years. Demand in each market area is expected to increase by about 20 percent. Demand in the Danville area is expected to remain constant, while demand in the Alexandria area is expected to increase by 50 percent.
Exhibit 3:
| Market |
Current Demand cwt/day |
5 years demand cwt/day |
Currently served by plant at |
| Alexandria |
500 |
750 |
Alexandria |
| Charlottesville |
200 |
240 |
Alexandria
|
| Roanoke |
300 |
360 |
Roanoke |
| Danville |
150 |
150 |
Roanoke |
| Richmond |
600 |
720 |
Richmond |
| Norfolk |
500 |
600 |
Norfolk |
| Total |
2250 |
2820 |
|
The shipping costs between each plant and each marketing area are shown in Exhibit 4. These costs may vary because of the distances involved and the mode of transportation used. Projected shipping costs for the new plant at Arlington are also shown in Exhibit 4. If the new plant is built at Arlington, it will cost $2 million to construct, and the plant will have approximately a 20-year lifetime. The company would utilize the new Arlington plant and existing plants which would be kept open for approximately 300 days each year.
Exhibit 4:
| Market |
Alexandria |
Richmond |
Norfolk |
Roanoke |
Arlington |
| Alexandria |
$2.50 |
$3.80 |
$5.20 |
$4.60 |
$2.60 |
| Charlottesville |
3.40 |
3.20 |
4.10 |
3.10 |
3.50 |
| Roanoke |
4.60 |
3.10 |
3.80 |
2.90 |
4.70 |
| Danville |
5.20 |
2.90 |
3.10 |
3.30 |
5.10 |
| Richmond |
3.80 |
2.80 |
2.90 |
3.10 |
3.70 |
| Norfolk |
4.60 |
2.60 |
2.60 |
4.40 |
4.50 |
The Arlington plant, if built, could be brought on-line in one year. In order to justify building the plant, Commonwealth Ice Cream expects to earn at least 10percent real return on its investment after tax. Corporate taxes are 35 percent of pretax net income. The new plant can be depreciated over a 20-year period on a straight line basis. The ages of existing plants and their salvage values if they were to shut down are shown in Exhibit 5. The salvage values assume the existing buildings and equipments can be sold off to the highest bidder.
Exhibit 5:
| Plant |
Age in Years |
Salvage in $000 |
| Alexandria |
23 |
450 |
| Richmond |
15 |
600 |
| Norfolk |
9 |
800 |
| Roanoke |
4 |
400 |
Discussion Questions:
Should the new ice cream plant be built at Arlington, Virginia?
What other actions should the company take?
What assumptions are required in your answer to question 1?
What risks are there in building the new plant now?