The Damon Company is a national

portable building manufacturer. Its Benton plant will become idle on December 31, 2017. Mary

Carter, the corporate controller, has been asked to look at three options regarding the plant:

Option 3: The plant, which has been fully depreciated for tax purposes, can be sold

immediately for $750,000.

Option 4: The plant can be leased to the Timber Corporation, one of Damon's suppliers,

for 4 years. Under the lease terms, Timber would pay Cook $175,000 rent per year

(payable at year-end) and would grant Cook a $60,000 annual discount from the normal

price of lumber purchased by Cook. (Assume that the discount is received at year-end

for each of the 4 years.) Timber would bear all of the plant's ownership costs. Cook

expects to sell this plant for $250.---,000 at the end of the 4-year lease.

Option 3: The plant could be used for 4 years to make porch swings as an accessory to

be sold with a portable building. Fixed overhead costs (a cash outflow) before any

equipment upgrades are estimated to be $22,000 annually for the 4-year period. The

swings are expected to sell for $45 each. Variable cost per unit is expected to be $22.

The following production and sales of swings are expected: 2018, 12,000 units; 2019,

18,000 units; 2020, 15,000 units; 2021, 8,000 units. In order to manufacture the swings,

some of the plant equipment would need to be upgraded at an immediate cost of

$180,000. The equipment would be depreciated using the straight-line depreciation

method and zero terminal disposal value over the 4 years it would be in use. Because of

the equipment upgrades, Damon could sell the plant for $320,000 at the end of 4 years. No

change in working capital would be required.

Required:

Cook Company treats all cash flows as if they occur at the end of the year, and uses an after-tax

required rate of return of 8%. Cook is subject to a 40% tax rate on all income, including capital

gains.

1. Calculate net present value of each of the options and determine which option Damon should

select using the NPV criterion.

2. What nonfinancial factors should Cook consider before making its choice?

3. Calculate the IRR if annual cash flows increases by 10%.

4. Determine the Weighted Average Cost of Capital.