Katie Burns was recently hired as a cost analyst by WellCare Medical Supplies, Inc. One of Katies first assignments was to perform a net present value analysis for a new warehouse. Katie performed the analysis and calculated a present value index of 0.75. The plant manager, Samuel McHenry, is very intent on purchasing the warehouse because he believes that more storage space is needed. Samuel asks Katie into his office and the following conversation takes place:

Samuel: Katie, youre new here, arent you?

Katie: Yes, sir.

Samuel: Well, Katie, Im not at all pleased with the capital investment analysis that you performed on this new warehouse. I need the warehouse for my production. If I dont get it, where am I going to place our output?

Katie: Hopefully with the customer, sir.

Samuel: Now dont get smart with me.

Katie: No, really, I wasnt trying to be disrespectful. My analysis does not support constructing a new warehouse. The numbers dont lie; the warehouse does not meet our investment return targets. In fact, it seems to me that purchasing a warehouse does not add much value to the business. We need to be producing product to satisfy customer orders, not to fill a warehouse.

Samuel: Listen, you need to understand something. J The headquarters people will not allow me to build the warehouse if the numbers dont add up. You know as well as I that many assumptions go into your net present value analysis. Why dont you relax some of your assumptions so that the financial savings will offset the cost?

Katie: Im willing to discuss my assumptions with you. Maybe I overlooked something.

Samuel: Heres what I want you to do. I see in your analysis that you dont project greater sales as a result of the warehouse. It seems to me, if we can store more goods, then we will have more to sell. Thus, logically, a larger warehouse translates into more sales. If you incorporate this into your analysis, I think youll see that the numbers will work out. Why dont you work it through and come back with a new analysis. Im really counting on you on this one. Lets get off to a good start together and see if we can get this project accepted.

Required: What is your advice to Katie? Is Samuel correct in his assumptions? Be specific in your discussion.