Selling a plant, income taxes. (CMA, adapted) The Crossroad Company is an international clothing manufacturer. Its Winnipeg plant will become idle on December 31, 2008. Peter Laney, the corporate controller, has been asked to look at three options regarding the plant. Option 1: The plant, which has been fully amortized for tax purposes, can be sold imme- diately for $340,000. Option 2: The plant can be leased to the Austin Corporation, one of Crossroad's sup- pliers, for four years. Under the lease terms, Austin would pay Crossroad $96,000 rent per year (payable at year-end) and would grant Crossroad a $18,960 annual discount off the normal price of fabric purchased by Crossroad (assume discount received at year-end for each of the four years). Austin would bear all of the plant's ownership costs. Crossroad expects to sell this plant for $80,000 at the end of the four-year lease. Option 3: The plant could be used for four years to make souvenir jackets for the Olympics. Fixed overhead costs (a cash outflow) before any equipment upgrades are esti- mated to be $8,000 annually for the four-year period. The jackets are expected to sell for $42 each. Variable cost per unit is expected to be $33. The following production and sales of jackets are expected: 2009, 8,000 units; 2010, 12,000 units; 2011, 16,000 units; 2012, 4,000 units. In order to manufacture the jackets, some of the plant equipment would need to be upgraded at an immediate cost of $60,000. The equipment would be amortized using the straight-line amortization method and zero terminal disposal value over the four years it would be in use. Because of the equipment upgrades, Crossroad could sell the plant for $120,000 at the end of four years. No change in working capital would be required. Crossroad treats all cash flows as if they occur at the end of the year, and it uses an after- tax required rate of return of 12%. Crossroad is subject to a 40% tax rate on all income, including capital gains. The plant is subject to 5% CCA rate declining balance for income tax purposes.LO1

Transcribed Image Text:

REQUIRED 1. Calculate net present value of each of the options and determine which option Crossroad should select using the NPV criterion. 2. What nonfinancial factors should Crossroad consider before making its choice?