Question: The Raleigh Soap Company has been offered a 5-year contract to manufacture and package a leading brand of soap for Taker Bros. It is understood that the contract will not exceed past the 5 years because Taker Bros. plans to build its own plant nearby. The contract calls for 10,000 metric tons (one metric ton equals 1000 kg) of soap a year, Raleigh normally produces 12,000 metric tons of soap a year, so production for the 5-year period would be increased to 22,000 metric tons. Raleigh must decide what changes, if any, to make to accommodate this increased production. Five projects are under consideration:
Project 1: Increase liquid storage capacity.Raleigh has been forced to buy caustic soda in tank truck quantities owing to inadequate storage capacity. If another liquid caustic soda tank is installed to hold 1000 cubic meters, the caustic soda may be purchased in railroad tank car quantities at a more favorable price. The result would be a saving of 0.1cent per kilogram of soap. The tank, which would cost $83,400 has no net salvage value.
Project 2: Acquire another sulfonation unit. The present capacity of the plant is limited by the sulfonation unit. The additional 12,000 metric tons of soap cannot be produced without an additional sulfonation unit. Another unit can be installed for $320,000.
Project 3: Expand the packaging department.With the new contract, the packaging department must either work two 8-hour shifts or have another packaging line installed. If the two-shift operation is used, a 20% wage premium must be paid for the second shift. This premium would amount to $35,000 a year. The second packaging line would be installed for $150,000. It would have a $42,000 salvage value at the end of 5 years.
Project 4: Build a new warehouse. The existing warehouse will be inadequate for the greater production. It is estimated that 400 square meters of additional warehouse is needed. A new warehouse can be built on a lot beside the existing warehouse for $225,000, including the land. The annual taxes, insurance, and other ownership costs would be $5000 a year. It is believed the warehouse could be sold at the end of 5 years for $200,000.
Project 5: Lease a warehouse. An alternative to building an additional warehouse would be to lease warehouse space. A suitable warehouse one mile away could be leased for $15,000 per year. The $15,000 includes taxes, insurance and so forth. The annual cost of moving materials to this more remote warehouse would be $34,000 a year.
The contract offered by Taker Bros. is a favorable one, which Raleigh Soap plans to accept. Raleigh management has set a 15% before-tax minimum attractive rate of return (MARR) as the criterion for any of the projects. Which projects should be undertaken?