2. In 2016, the Sunshine Chemical Company prepared the following analysis of an investment proposal for a new manufacturing facility: *Computation of depreciation tax shield: Annual straight-line depreciation ($810,000/5) . . . . . . . . . . . . . . $162,000 Tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 0.40 Depreciation tax shield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 64,800 Because the proposal had a positive net present value when discounted at Sunshines cost of capital of 12 percent, the project was approved; all investments were made at the end of 2017. Shortly after production began in January 2018, a government agency notified Sunshine of required additional expenditure totaling $200,000 to bring the plant into compliance with new federal emission regulations. Sunshine has the option either to comply with the regulations by Dec 31, 2018, or to sell the entire operation (fixed assets and working capital) $250,000 on December 31, 2018. The improvements will be depreciated over the remaining four-year life of the plant using straight-line depreciation. The cost of site restoration will not be affected by the improvements. If Sunshine elects to sell the plant, any book loss can be treated as an offset against taxable income on other operations. This tax reduction is an additional cash benefit of selling. Required 20 points a. Should Sunshine sell the plant or comply with the new federal regulations? To simplify calculations, assume that any additional improvements are paid for on December 31, 2018. b. Would Sunshine have accepted the proposal in 2017 if it had been aware of the forthcoming federal regulations? c. Do you have any suggestions that might increase the projects net present value? (No calculations are required.)

Year(s) of Cash (outflows)Flows Predicted Cash Inflows 12% Present Value Factor Present Value of Cash FlowS (C)(A) x (C) Initial investment 1.000 1.000 s (810,000) (100,000) Operations Annual taxable income Taxes on income (S310,000 x 0.40) 1,117,550 (447,020) 233,604 (45,360) 18,144 Depreciation tax shield. . . . 64,800 1-5 Disinvestment 80,000 32,000 Net present value of all cash flows......... . . . . . 0.567 Tax shield of restoration 0.567 0.567 56,700 . . . . .. . . . . . . . . 23,618