Anthony Company's capital budgeting committee is evaluating a capital expenditure proposal for the production of a high definition television receiver to be sold as an add-on feature for personal computers. The proposal calls for an independent contractor to construct the necessary facilities by December 31, 20 I0, at a total cost of $250,000. Payment for all construction costs will be made on that date. An additional $50,000 in cash will also be made available on December 31, 2010, for working capital to support sales and production activities.
Management anticipates that the receiver has a limited market life; there is a high probability that by 2017 all new PCs will have built-in high definition receivers. Accordingly, the proposal specifies that production will cease on December 31, 2016. The investment in working capital will be recovered on that date, and the production facilities will be sold for $30,000. Predicted net cash inflows from operations for 20 II through 2016 are as follows:
2011 ………………………………………. $100,000
2012 ………………………………………. 100,000
2013 ………………………………………. 100,000
2014 ………………………………………. 40,000
2015 ………………………………………. 40,000
2016 ………………………………………. 40,000
Anthony Company has a time value of money of 16 percent. For capital budgeting purposes, all cash flows are assumed to occur at the end of each year.
Answer the following question:
a) Assume that the capital expenditure proposal is accepted, but construction delays caused by labor problems and difficulties in obtaining the necessary construction permits delay the completion of the project. Payments totaling $200,000 were made to the construction company on December 31, 2010, for that year's construction. However, completion is now scheduled for December 31, 2011, and an additional $100,000 will be required to complete construction. If the project is continued, the additional $100,000 will be paid at the end of 2011, and the plant will begin operations on January 1, 2012.
Because of the cost overruns, the capital budgeting committee requests a reevaluation of the project in early 2011, before agreeing to any additional expenditures. After much effort, the following revised predictions of net operating cash inflows are developed:
2012 ………………………………………. $120,000
2013 ………………………………………. 100,000
2014 ………………………………………. 40,000
2015 ………………………………………. 40,000
2016 ………………………………………. 40,000
The working capital investment and disinvestment and the plant salvage values have not changed, except that the cash for working capital would now be made available on December 31, 2011. Use the net present value method to reevaluate the initial decision to accept the proposal. Given the information currently available about the project, should it have been accepted in 20 10?