Problem:
Senior management is considering two new warehouse locations in order to serve its customers in the North and West more efficiently. Unfortunately, the company only has sufficient funds to invest into only one warehouse location at this time. Each warehouse will require that a new building be constructed. Claire's Antiques expects to use the warehouse for five (5) years before building a new production facility in that area. Senior management hired a consulting firm to research the potential warehouse locations. You were at a meeting with the researchers and they gave you the results of the research.
The results of their research
Proposal 1 Proposal 2
New Warehouse Location North Warehouse West Warehouse
Estimated first year revenue increase $650,000 $900,000
Estimated annual revenue growth 7% 8%
Estimated contribution margin % 55% 45%
Marginal tax rate 40% 40%
Estimated annual fixed costs $100,000 $120,000
Investment in facility $1,500,000 $1,700,000
One-time advertising in year 0 $140,000 $150,000
Estimated salvage value in year 6 $125,000 $120,000
Use the following assumptions:
Assume the risk-adjusted cost of capital is 10% and its tax rate is 40%. Compute the net present value (NPV) for each warehouse proposal. Include the cash flows from salvage value and the tax benefits of depreciation (assume 5-year straight-line). Incorporate the research data and graphs and charts into your presentation for support to your recommendation.
Include in your presentation recommendations on the desired warehouse location for senior management. Specify how your recommendation is affected by your assumptions for cost of capital and expected contribution margin (that is, perform a sensitivity analysis)?
Table Method (10%)
Period
1 0.9091
2 0.8264
3 0.7513
4 0.6830
5 0.6209
6 0.5645
7 0.5132
8 0.4665
9 0.4241
10 0.3885
15 0.2394
20 0.1486
25 0.0923