Payback, Net Present Value, Internal Rate of Return, Effects of Differences in Sales on Project Viability

For discount factors use Exhibit 12B-1 and Exhibit 12B-2.

Shaftel Ready Mix is a processor and supplier of concrete, aggregate, and rock products. The company operates in the intermountain western United States. Currently, Shaftel has 14 cement- processing plants and a labor force of more than 375 employees. With the exception of cement powder, all materials (e.g., aggregates and sand) are produced internally by the company. The demand for concrete and aggregates has been growing steadily nationally. In the West, the growth rate has been above the national average. Because of this growth, Shaftel has more than tripled its gross revenues over the past 10 years.

Of the intermountain states, Arizona has been experiencing the most growth. Processing plants have been added over the past several years, and the company is considering the addition of yet another plant to be located in Scottsdale. A major advantage of another plant in Arizona is the ability to operate year round, a feature not found in states such as Utah and Wyoming.

In setting up the new plant, land would have to be purchased and a small building constructed. Equipment and furniture would not need to be purchased. These items would be transferred from a plant that opened in Wyoming during the oil boom period and closed a few years after the end of that boom. However, the equipment needs some repair and modifications before it can be used. The equipment has a book value of $200,000, and the furniture has a book value of $30,000. Neither has any outside market value. Other costs, such as the installation of a silo, well, electrical hookups, and so on, will be incurred. No salvage value is expected. The summary of the initial investment costs by category is as follows:

Land		$20,000
Building		135,000
Equipment:
Book value		200,000
Modifications		20,000
Furniture (book value)		30,000
Silo		20,000
Well		80,000
Electrical hookups		27,000
General setup		50,000
Total		$582,000

Estimates concerning the operation of the Scottsdale plant follow:

Life of plant and equipment		10 years
Expected annual sales (in cubic yards of cement)		35,000
Selling price (per cubic yard of cement)		$45.00
Variable costs (per cubic yard of cement):
Cement		$12.94
Sand/gravel		6.42
Fly ash		1.13
Admixture		1.53
Driver labor		3.24
Mechanics		1.43
Plant operations (batching and cleanup)		1.39
Loader operator		0.50
Truck parts		1.75
Fuel		1.48
Other		3.27
Total variable costs		35.08
Fixed costs (annual):
Salaries		135,000
Insurance		75,000
Telephone		5,000
Depreciation		58,200	*
Utilities		25,000
Total fixed costs		298,200

*Straight-line depreciation is calculated by using all initial investment costs over a 10-year period, assuming no salvage value.

After reviewing these data, Karl Flemming, vice president of operations, argued against the proposed plant. Karl was concerned because the plant would earn significantly less than the normal 8.3% return on sales. All other plants in the company were earning between 7.5 and 8.5% on sales. Karl also noted that it would take more than 5 years to recover the total initial outlay of $582,000. In the past, the company had always insisted that payback be no more than 4 years. The company's cost of capital is 10%. Assume that there are no income taxes.

Required:

Question Content Area

1. Prepare a variable-costing income statement for the proposed plant.

Shaftel Ready Mix Income Statement For the Proposed Plant

Line Item Description	Amount	Amount
Contribution marginDepreciationInsuranceSalesUtilitiesSales		$Sales
Less: Contribution marginLess: SalariesLess: SalesLess: TelephoneLess: Variable expensesLess: Variable expenses		Less: Variable expenses
Contribution marginDepreciationInsuranceTelephoneUtilitiesContribution margin		$Contribution margin
Less fixed expenses:
CashContribution marginSalariesSalesVariable expensesSalaries	$Salaries
Contribution marginInsuranceLandPlantSalesInsurance	Insurance
CashContribution marginSalesTelephoneVariable expensesTelephone	Telephone
Contribution marginDepreciationPlantSalesVariable expensesDepreciation	Depreciation
Contribution marginLandSalesUtilitiesVariable expensesUtilities	Utilities	Utilities
Net incomeNet lossNet income		$Net income

Feedback Area

Feedback

1. Prepare income statement in proper form with company name, statement name and date. List sales less variable expenses for contribution margin. Subtract fixed expenses for net income. Calculate ratio of net income to sales by dividing net sales by net income.

Question Content Area

Compute the ratio of net income to sales. Enter as a percent, rounded to two decimal places. fill in the blank 1 of 1%

Is Karl correct that the return on sales is significantly lower than the company average?

YesNoYes

2. Compute the payback period for the proposed plant. Round to two decimal places. fill in the blank 1 of 1 years

Is Karl right that the payback period is greater than 4 years?

YesNoNo

3. Compute the NPV and the IRR for the proposed plant. Round present value calculations and final NPV to the nearest dollar.

Line Item Description	Answer
NPV	fill in the blank 1 of 2$
IRR	fill in the blank 2 of 2 The IRR is between 16% and 18%The IRR is between 18% and 20%The IRR is between 20% and 25%The IRR is between 25% and 30%The IRR is between 25% and 30%

Would your answer be affected if you were told that the furniture and equipment could be sold for their book values?

YesNoYes

If your answer would be affected if you were told that the furniture and equipment could be sold for their book values, repeat the analysis with this effect considered. If not, leave the entry boxes blank. Round present value calculations and final NPV to the nearest dollar.

Line Item Description	Answer
NPV	fill in the blank 1 of 2$
IRR	fill in the blank 2 of 2 The IRR is between 12% and 14%The IRR is between 14% and 15%The IRR is between 15% and 16%The IRR is between 12% and 14%

4. Compute the cubic yards of cement that must be sold for the new plant to break even. Round your answer to the nearest whole number. fill in the blank 1 of 1 cubic yards

Using this break-even volume, compute the NPV and the IRR. Round present value calculations and final NPV to the nearest whole dollar.

Line Item Description	Answer
NPV	fill in the blank 1 of 2$
IRR	fill in the blank 2 of 2 The IRR is between 9% and 10%The IRR is between 11% and 12%The IRR is between 10% and 11%The IRR is between 9% and 10%

Would the investment be acceptable?

YesNoNo

5. Compute the volume of cement that must be sold for the IRR to equal the firm's cost of capital. Round your answer to the nearest whole number. fill in the blank 1 of 1 cubic yards

Using this volume, compute the firm's expected annual income. Round your answer to the nearest whole dollar. fill in the blank 1 of 1$per year