Reference no: EM133506394
Riley Surf Boards is expanding so they are considering building a new factory. John Smith, the company's marketing manager, fully supports building the new factory. Mary Reynolds, the company's chief financial officer, is not so sure that building a new factory is a good idea. Currently, the company purchases its surf boards from various foreign manufacturers. The following figures were estimated regarding the construction of the new factory.
Cost of factory $4,000,000
Annual cash inflows 4,000,000
Annual cash outflows 3,540,000
Estimated useful life 15 years
Salvage value $2,000,000
Discount rate 11%
John Smith believes that these figures understate the potential value of building the new factory. He suggests that by manufacturing its own skateboards the company will benefit from a "buy American" patriotism that he believes is common among surfers. He also states that the company has had many quality problems with the surf boards that have been manufactured by the foreign manufacturers. He has suggested that the poor quality has resulted in declining sales, increased warranty claims, and even some lawsuits. Overall, he believes sales will increase by $200,000 more than projected above, and that the savings in warranty and legal costs will be around $60,000 per year. He also adds that the project is not as risky as assumed above, and that a 9% discount rate is more reasonable. (Hint: Use a PV Table for Annuity)
1. Compute the net present value of the project based on the original projections. Explain how you computed it.
2. Compute the net present value incorporating John's estimates of the value of the intangible benefits, but still using the 11% discount rate. Explain how you computed it.
3. Compute the present value using the original estimates but employing the 9% discount rate that John suggests is more appropriate. Explain how you computed it
4. Comment on your findings. Should the company build a new factory? Why or why not?