Reference no: EM132978980

Question - Overland Steel - Overland Steel operates a coal-burning steel mill in New York State. Changes in the state's air quality control laws will result in this mill's incurring a $1,000 per day fine (which will be paid at the end of the year) if it continues to operate. The mill currently operates every day of the year.

The mill was built 20 years ago at a cost of $15 million and has a remaining undepreciated book value of $3 million. The expected remaining useful life of the mill is 30 years.

The firm can sell the mill to a developer who wants to build a shopping center on the site. The buyer will pay $1 million for the site if the company demolishes the mill and prepares the site for the developer. Demolition and site preparation costs are estimated at $650,000.

Alternatively, the firm could install pollution control devices and other modernization devices at an initial outlay of $2.75 million. These improvements do not extend the useful life or salvage value of the plant, but they do reduce net operating costs by $25,000 per year in addition to eliminating the $1,000 per day fine. Currently, the net cash flows of operating the plant are $450,000 per year before any fines.

Assume:

The market rate of interest is 14 percent.

There are no taxes.

The annual cash flow estimates given above are constant over the next 30 years.

At the end of the 30 years, the mill has an estimated salvage value of $2 million whether or

not the pollution equipment has been installed.

Required - Evaluate the various courses of action available to management and make a recommendation. Support your conclusions with neatly labeled calculations where possible.