A small group of investors is considering building a small premixed-concrete plant in a rapidly developing suburban area about 15 miles from a large city. The group believes that there will be a good market for premixed concrete in this area for at least the next 10 years, and that if they establish such a local plant, it will be unlikely that another local plant would be established. Existing plants in the adjacent large city would, of course, continue to serve this new area. The investors believe that the plant could operate, in average, 250 days per year, because it is located in an area where the weather is mild throughout the year.

The potential demand has been estimated at about 315 cubic yards of concrete per day. A plant design has been identified which has a 420 cubic-yard capacity (it would therefore operate at an average 75 percent of capacity).The plant would cost $850,000 to build, including all production equipment and a small mobile-type office. The plant's market value at the end of ten years is estimated to be null. The land upon which the plant will be built would cost $20,000 and is expected to be sold for the same amount in actual dollars in 10 years.

To deliver the concrete, four secondhand trucks can be acquired, costing $18,000 each, having an estimated life of 5 years and a market value of $500 when sold (unless otherwise stated, all prices and costs given, are given in real, year-0 dollars which must be adjusted for inflation in outlying years). In addition to the four truck drivers, who would be paid $50 per day each, four people would be required to operate the plant and office, at a combined cost of $175 per day for all four. Payroll taxes, vacations, and other fringe benefits would amount to 25 percent of the annual payroll. Annual taxes and insurance on each truck would be $500, and taxes and insurance on the plant would be $1,000 per year. The investors would not contribute any labor to the business, but a manger would be employed at an annual salary of $20,000 (also requires 25 percent for fringes, tax, etc.). It can be reasonably assumed that the expense items of labor, payroll taxes, benefits, property taxes and insurance are fixed costs, i.e. they would be virtually unaffected if capacity utilization should vary over a wide range.

Annual operating and maintenance (O&M) expenses for the plant and office are estimated at $7,000, and for each truck at $2,250, assuming 75 percent capacity utilization. A reasonable assumption is that 50 percent of these O&M expenses are fixed expenses, the other 50 percent will vary with capacity utilization (for example, if capacity utilization is 60 percent, then plant and office O&M expenses would be $3,500 + $3,500(60/75) = $6,300.Truck O&M expenses vary the same way).

Material costs are estimated to be $12 per cubic yard of concrete. Delivered, premixed concrete is selling for an average of $17.25 per cubic yard. A useful plant life of 10 years is expected, and capital invested elsewhere by these investors is earning about 12 percent per year after income taxes [this MARR is a combined (market) interest rate]. The marginal income tax rate for this new business would be 15 percent. Fifty percent of the total investment will be financed by means of a 10-year loan, with 7 percent annual interest and equal payments.For depreciation purposes, the straight-line method with no salvage value should be used. The plant is depreciable over 10 years, and the trucks are depreciable over 5 years.

All prices and costs have been estimated at constant values (year-0, or real dollars as valued at the time of the analysis). General inflation rate is estimated at 3 percent per year, and will affect concrete selling price, truck market value, and all expenses, except for raw materials and truck O&M expenses, which are expected to increase at a total price escalation rate of 5 percent per year according to what has been observed in recent years. The value of land will remain unaffected by inflation (i.e., $20,000 actual dollars regardless of time of sale).

Question:

1.There are at least three factors of great importance in the project with considerable uncertainty in their estimations:

capacity utilization,

selling price of the product, and

raw material costs.

a.Determine the break-even points for the three factors.

b.Develop sensitivity tables and a "spider plot" for the NPV with respect to these factors. Uncertainty ranges should be at least 30 percent for each factor.