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Currently due to the coronavirus health crisis there is a great demand for medical face masks. Smooth Equipment company is considering purchase of a piece of land to build a manufacturing plant to produce medical face masks. The purchase price for the land is $100,000 and preparatory work will cost $34,200.
The manufacturing plant would be useable for 10 years. Company consultants recommend the new plant would cost the company $20,000 per year less to operate than the company's current production line. The current production plant also will last 10 more years. For a face mask manufacturing project, the company can borrow money at 4 per cent from the federal government.
Required:
Question 1: Calculate the net present value of the new manufacturing plant.
Note: Use annuity present value of 8.111 for your calculations.
Question 2: Explain three limitations of the payback method that the management of Smooth Equipment need to be aware of?
Question 3: Suppose the manager of Smooth Equipment is using capital budgeting to evaluate two alternative business opportunities. Both require comparable investments and have comparable average cash flows. However, the cash flows of one business appear to be more volatile than those of the other (ie. the cash flows of this opportunity vary more about its average). Is this an important consideration in capital budgeting? Justify your answer.
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