Canadian Rocky Mountain Construction Materials (CRCM) Inc. is a processor and supplier of building materials. The company operates mostly in Canada and the Western/Southern U.S. Currently, CRCM has 15 cement processing plants and 375 employees. All materials are produced internally by the company except for cement powder. The growth demand for CRCM's construction materials has been growing steadily especially in Texas. Because of this growth, CRCM has more than tripled its gross revenues over the past 10 years. Many processing plants have been added to the region in the past several years and the company is considering the addition of yet another plant to be located in El Paso. A major advantage of locating the plant in Texas, as opposed to Montana or British Columbia, is the ability to operate the plant year round.
In setting up the new plant, land would need to be purchased and a small building constructed. Equipment and furniture would not need to be purchased; these items would be transferred from a Montana plant that had closed a couple of years ago. However, the equipment needs some repair and modifications before it can be used. The equipment has a book value of $200,000 and the furniture has a book value of $30,000. Neither has any outside market value (i.e. cannot be sold or salvaged) thus no associated opportunity cost. Other costs such as installation of a silo, well, electrical hookups, and so on will be incurred. No salvage is expected. The summary of the initial investment costs by category is as follows:
|
Land
|
$20,000
|
|
Bldg
|
135,000
|
|
Equipment:
|
|
|
Book Value
|
200,000
|
|
Modifications
|
20,000
|
|
Furniture (book value)
|
30,000
|
|
Silo
|
30,000
|
|
Well
|
80,000
|
|
Electrical Hookups
|
27,000
|
|
General Setup
|
50,000
|
|
Total
|
$592,000
|
https://gyazo.com/5cfda23b9360c54fa0926b9eb5d759da
Estimates concerning the operation of the El Paso Plant follow:
|
Life of plant & equipment
|
10 years
|
|
Expected annual sales( in cubic yards of cement)
|
45,000yrds
|
|
Selling price (per cubic yard of cement)
|
$58.25
|
|
Variable costs (per cubic yard of cement):
|
|
|
Cement
|
$13.94
|
|
Sand and gravel
|
7.42
|
|
Fly ash
|
3.13
|
|
Admixture
|
3.53
|
|
Driver labor
|
7.24
|
|
Mechanics
|
3.75
|
|
Plant operations(batching & clean up)
|
1.39
|
|
Loader Operator
|
0.5
|
|
Truck parts
|
1.75
|
|
Fuel
|
1.48
|
|
Other
|
3.27
|
|
Total Variable Costs
|
$47.40
|
|
Fixed Costs(annual)
|
|
|
Salaries
|
$180,000
|
|
Insurance
|
85000
|
|
Telephone
|
18000
|
|
Depreciation* 59,200
|
|
|
Utilities
|
65,000
|
|
Total Fixed Costs
|
$407,200
|
https://gyazo.com/59458a19914f24c934b196308860e3fe
*Straight-line depreciation is calculated by using ALL initial investment costs over a 10 yr period assuming no salvage value.
After reviewing these data Maryam Murat, VP of operations, argued against the proposed plant. Maryam was concerned because the plant would earn significantly less than the normal 6.0 percent on sales. All other plants in the company were earning between 5.5 percent and 7.5 percent on sales. Maryam also noted that it would take more than four years to recover the total initial outlay of $592,000. In the past the company had always insisted that payback be no more than four years. The company's cost of capital is 10 percent. Assume there are no income taxes.
Required:
1. Prepare in good form a variable-costing income statement for the proposed plant. Compute the profit margin(return on sales). Is Maryam correct that the return on sales is significantly lower than the company average? Explain you answer.
2. Calculate the annual cash flow and compute the payback period for the plant. Is Maryam right that the payback period is greater than four years? Explain. Suppose you were told the equipment being transferred from Montana could be sold for its book value. Would this affect your answer?
3. Compute the NPV and IRR for the proposed plant. Would your answer be affected if you were told that the furniture and equipment could be sold for their book values? If so repeat the analysis with this effect considered.
4. Compute the cubic yards of construction materials that must be sold for the new plant to breakeven. Using this breakeven volume, compute the NPV and the IRR. Would the investment be acceptable? If so, explain why an investment that promises to do nothing more than breakeven can be viewed as acceptable.
5. Compute the volume of cement that must be sold for the IRR to equal the firm's cost of capital. Using this volume, compute the firm's expected annual income. Explain this result.