Reference no: EM1321021
In 2010, the Bayside Chemical Company prepared the following analysis of an investment proposal for a new manufacturing facility:
Because the proposal had a positive net present value when discounted at Bayside's cost of capital of 12 percent, the project was approved; all investments were made at the end of 2011. Shortly after production began in January 2012, a government agency noticed Bayside of required additional expenditures totaling $200,000 to bring the plant into compliance with new federal emission regulations. Bayside has the option either to comply with the regulations by December 31, 2012, or to sell the entire operation fixed assets and working capital) for $250,000 on December 31, 2012. The improvements will be depreciated over the remaining four-year life of the plant using straight-line depreciation. The cost of site restoration will not be affected by the improvements. If Bayside elects to sell the plant, any book loss can be treated as an offset against taxable income on other operations. This tax reduction is an additional cash benefit of selling.
Required
a. Should Bayside sell the plant or comply with the new federal regulations? To simplify calculations, assume that any additional improvements are paid for on December 31, 2012.
b. Would Bayside have accepted the proposal in 2011 if it had been aware of the forthcoming federal regulations?
c. Do you have any suggestions that might increase the project's net present value? (No calculations are required.)
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