You are the CEO (Chief Executive Officer) of a large industrial grade Group of Bakeries, the operation has been exceptionally profitable, and the Group now has a considerable amount of cash. The Board of Directors has decided to invest the money in expanding the operation rather than distributing dividends to the shareholders. The Marketing Department has identified a new market segment, of which your Group of Bakeries can get a considerable share. You decide, therefore, to build a new Production Line; you issue an RFP (Request For Proposal) for the implementation of this new Production Line.

Three Contractors submit their Proposals: one Contractor proposes a low-price Line, another proposes a medium priced one, and a third proposes a state-of-the art computer-controlled Line. Their proposals are summarized as follows:

Low Price Option

• Price: $ 1,000,000
• Operation & Maintenance: the anticipated O&M cost is $ 25,000 per year and is expected to increase, due to wear and tear, by a $ 1,000 per year
• Overhaul need : it is expected that every 5 years there will be the need of a major overhaul at a cost of $ 20,000. After each overhaul, the cost of O&M decreases to its original value ($ 25,000/yr) and then increases again at the same rate ($ 1,000/yr). No overhaul is done at the end of useful life.
• Anticipated Yearly Revenues: it is anticipated that the new production line will produce sales revenues in the amount of $ 200,000 per year, and that such revenues will increase by $ 10,000 per year
• Useful Life: the useful life of this production line is expected to be 20 years
• Salvage Value: at the end of its useful life, the line will be sold on the used market for an anticipated price of $ 50,000

Medium Price Option

• Price: $ 2,000,000
• Operation & Maintenance: the anticipated O&M cost is $ 20,000 per year and is expected to increase, due to wear and tear, by a $ 1,500 per year

• Overhaul need: it is expected that after 10 years there will be the need of a major overhaul at a cost of $ 40,000. After the overhaul, the cost of O&M decreases to its original value ($ 20,000/yr) and then increases again at the same rate ($ 1,500/yr). ). No overhaul is done at the end of useful life.
• Anticipated Yearly Revenues: it is anticipated that the new production line will produce sales revenues in the amount of $ 350,000 per year, and that such revenues will increase by $ 6,000 per year
• Useful Life: the useful life of this production line is expected to be 20 years

• Salvage Value: at the end of its useful life, the line will be sold on the used market for an anticipated price of $ 120,000

State-of-the-Art Option

• Price: $ 4,000,000
• Operation & Maintenance: the anticipated O&M cost is $ 30,000 per year and is expected to increase, due to wear and tear, by a $ 2,500 per year
• Overhaul need: this production line will not need any overhaul during its useful life
• Anticipated Yearly Revenues: it is anticipated that the new production line will produce sales revenues in the amount of $ 500,000 per year, and that such revenues will increase by $ 5,000 per year
• Useful Life: the useful life of this production line is expected to be 20 years
• Salvage Value: at the end of its useful life, the line will be sold on the used market for an anticipated price of $ 120,000

Answer the following questions, and show the calculations in support of your answers:

1. If the cost of capital for your Group of Bakeries is 7% what proposal should you choose?
2. If the cost of capital for your Group of Bakeries is 14% what proposal should you choose?
3. What cost of capital would make the Low-Price option economically identical to the Medium-Price Option?
4. What cost of capital would make the Medium-Price option economically identical to the State-of-the-art Option?
5. What cost of capital would make none of the three options economically feasible?