Problem:
Lou Lewis, the president of Lewisville Company has asked you to give him an analysis of the best use of a warehouse the company owns.
a. Lewisville Company currently is leasing the warehouse to another company for $5000 per month on a year-to-year basis.
b. The warehouse’s estimated sales value is $200,000. A commercial Realtor believes that the price is likely to remain unchanged in the near future. The building originally cost $60,000 and is being depreciated at $1,500 annually. It’s current net book value is $7,500.
c. Lewisville Company is seriously considering converting the warehouse into a factory outlet for furniture. The remodeling will cost $100,000 and will be modest because the major attraction will be rock-bottom prices. The remodeling will be depreciated over the next five years using the double-declining balance method.
d. The inventory, cash, and receivables needed to open and sustain the factory outlet would be $600,000. This total is fully recoverable whenever operations terminate.
e. Lou is fairly certain that the warehouse will be condemned in ten years to make room for a new highway. The firm most likely would receive $200,000 from the condemnation.
f. Estimated operating data, exclusive of depreciation, are
SALES $900,000
OPERATION EXPENSES $500,000
g. Nonrecurring sales promotion costs at the beginning of year 1 are expected to be $100,000.
h. Nonrecurring termination costs at the end of year 5 are $50,000.
i. The minimum annual rate of return desired is 14 percent. The company is in the 40 percent tax bracket.
Required:
1. Show how you would handle the individual items in determining whether the company should continue to lease the space or convert it to a factory outlet. Use the company’s analysis form, which is set up as follows.
Item Description NPV Cash Flows in Years
0 1 2 3 4 5
A.
B.
.
.
.
I.
Identify any item that is irrelevant.
2. After analyzing all relevant data, compute the Net Present Value. Indicate which course of action, based only on these data, should be taken.