Reference no: EM132929618
Incorporating a Long-Term Horizon into the Decision Analysis
Assume that Allyson's relevant analysis reveals that NoFat would earn a positive relevant profit of $10,000 from the special sale (i.e., the special sales alternative). However, after conducting this traditional, short-term relevant analysis, Allyson wonders whether it might be more profitable over the long-term to downsize the company by reducing its manufacturing capacity (i.e., its plant machinery and plant facility). She is aware that downsizing requires a multiyear time horizon because companies usually cannot increase or decrease fixed plant assets every year. Therefore, Allyson has decided to use a 5-year time horizon in her long-term decision analysis. She has identified the following information regarding capacity downsizing (i.e., the downsizing alternative):
- The plant facility consists of several buildings. If it chooses to downsize its capacity, NoFat can immediately sell one of the buildings to an adjacent business for $30,000.
- If it chooses to downsize its capacity, NoFat's annual lease cost for plant machinery will decrease to $9,000.
Therefore, Allyson must choose between these two alternatives: Accept the special sales offer each year and earn a $10,000 relevant profit for each of the next 5 years or reject the special sales offer and downsize as described above.
Assume that NoFat pays for all costs with cash. Also, assume a 10% discount rate, a 5-year time horizon, and all cash flows occur at the end of the year. Use an NPV approach to discount future cash flows to present value. To determine NPV, use the Exhibit to locate the present value of $1 to be multiplied by the cash inflow in Year 1.
Problem a. Calculate the NPV of accepting the special sale with the assumed positive relevant profit of $10,000 per year (i.e., the special sales alternative). Round your answer to the nearest dollar.
Problem b. Calculate the NPV of downsizing capacity as previously described (i.e., the downsizing alternative). Round your answer to the nearest dollar.
Problem c. Based on the NPV of Calculations a and b, identify and explain which of these two alternatives is best for NoFat to pursue in the long term.