You are the General Manager of Palermo Corporation, a manufacturer of track and field equipment. Palermo has recently developed a new GPS device that lets runners know their pace and locates their position on the course (useful for road races). Your existing plant needs to be expanded to pursue this opportunity. You are examining two approaches to this facilities problem Approach A build a greenfield plant for this opportunity. Cost of this approach is $2.5M in machinery cost and $2.5M in brick and mortar. The machinery has an expected economic life of 10 years and the buiding a life of 25 years. Both items would be depreciated straight line over their respective economic lives. Assume all the plant and machinery payments are made at time-zero. Approach B rent a nearby facility at a annual lease cost of $400,000. You will still have to purchase the machinery for $2.5M at time -zero. However, your lease negotaion will only hold the intial rent of $400,000 for 5 yrs. The lease cost will increase to $500,000 per year for the renewal term (Yrs 6-10) Because of the fast moving technology of the GPS system, you are uncertain as to whether the equipment refresh needed in 10 years (the economic life of the initial equipment set) would require the same plant footprint/capacity as today Therefore, you will analyze both alternatives on just the first 10 yrs. If you follow Approach A and buy the facility, assume you can sell it for its undepreciated value of $1.5M in the 10th year (because you are selling the plant at its 'book' value, there is no tax impact on the sale- you would get the full $1.5M in cash at that time) Assume a 30% tax rate overall for both the depreciation deduction and any rental expenses. Your cost of capital is 10%. As the Benefits for both approaches are the same (attaining the GPS related revenues), you are looking for the approach (A or B) which has the lowest cost to Palermo. 1. Which Approach should you follow and Why? 2. Would you answer change if you only received $1M aftertax cash on the resale of the Plant after 10 yrs, instead of the expected $1.5M? Approach A Cost of Cost of Equipme Plant 0-3E-06 Depreciatio Afterta Resale Overall Data Inputs Initial Cost Annual Depreciati 350000 Rental Cost Yr1-5 Rental Cost Yr 6- Tax Rate Resale of Plant2E+06 Discount Rate ye tax Shield Rental Cosl PlantCost 5E+06 2500000 5E 06 10% 0 2E+062E+06 Total E+06 2500000 0 2E+06-4E+06 NPy Approach B Cost of Cost of Equipme Plant 0-3E-06 Depreciatio Afterta Resale Overall Data Inputs Initial Cost Annual Depreciati 250000 Rental Cost Yr1-5-400000 Rental Cost Yr 6--500000 Tax Rate Resale of Plant Discount Rate ye tax Shield Rental Cosl PlantCost 5E+06 E+06 10% Total E+06 0-3E-06 NPy