The Board of Directors for Colton Industries, a diversified manufacturer of fiberglass products, is considering a proposal by the CEO to sell the firm's boat manufacturing division.
An anonymous buyer has offered through a business broker to purchase the boat division from Colton for $50 million. Since the book value of the boat division is also $50 million, there would be no taxes on the sale. Boat sales in the upcoming fiscal year are expected to be $40 million. However, yearly sales have been declining steadily at a rate of 4 percent per year. The CFO believes that the trend in boat sales cannot be reversed, and that sales in the boat division will continue to decline in perpetuity at a rate of 4 percent per year due to relentless competition from foreign manufacturers located in Paraguay. As further evidence supporting the proposed sale, the CEO notes that Colton's profit margin on boat sales is only 15 percent (of sales). The CFO has argued that selling the boat division is not attractive because the proposed sale has an internal rate of return that is less the firm's opportunity cost of capital of 10 percent. Assuming that Colton has a marginal tax rate of 30 percent,
a. Determine the internal rate of return for the proposed sale.
b. Explain whether Board should approve the sale of the boat division.