Case Scenario:
Johnson and Smith is a private company situated in Washington. It has been producing specialized machinery and selling it to various manufacturers nationwide. The factory has been in operation for many years and all its buildings and equipment are depreciated long time ago. It employs 50 people and has no union problems. The operation has been financially profitable. The production as shown in Table 1 is seasonal but steady from year to year which makes financial planning over the years easy and the future sales fairly predictable.
Table: Annual production in Tons:
|
Month
|
Jan
|
Feb
|
Mar
|
Apr
|
May
|
June
|
July
|
Aug
|
Sep
|
Oct
|
Nov
|
Dec
|
|
Production
|
100
|
150
|
200
|
300
|
300
|
300
|
300
|
300
|
200
|
150
|
100
|
50
|
The price of product delivered at the factory is $5,000/Ton during the months of January, February, March, October, November, December and $6,000/Ton in other months of the year. The total cost of producing each ton of the product is $4,000.
Because the factory is old it does not comply with the new nationwide environment requirements and causes pollution to the neighboring areas. The regulation forces the company to pick one of the two options:
Option A: Install new equipment to bring its emission to the acceptable standard.
Option B: Purchase pollution credit
Installation of the new equipment involves a purchase price of $1million with an installation cost of $200K and a maintenance cost of $50K annually. The pollution credit is going to cost $150 K per year. However the initial cost of the equipment and its installation can be depreciated. If option A is selected the company is going to choose SL depreciation schedule for the new equipment and its installation with an assumed life of 5 years for the purpose of depreciation and no resale value.
Meanwhile a county in the state of Utah who is looking for new development is proposing the owners of Johnson and Smith to move their operation to that county (option C). It is giving the following incentive to Johnson and Smith. The county will provide the land and the building with its facilities and will not impose any county tax for the first five years and 5% tax after that.
The new supper modern factory will cost $25M worth of equipment that can be depreciated using the MACRS schedule for a 5-year product. If Johnson and Smith decide to accept its proposal it has to pay $1.5M to move and dispose of the present factory equipment in Washington. However it can sell the land that they have originally obtained at no cost at a price of $300 K. The cost of terminating each employee is $50K.
The following additional information is provided:
*-The county tax in Washington is 4%
*-The federal income tax is 20%
*-The county tax is already paid before the end of the year
*-The federal tax is computed on income after the county tax is paid
*-there is no state tax to this business neither in Utah nor in Washington
*-The MARR for IS is 12%
*-The time horizon for this case is 10 years
*-10 of the employees who are in managerial positions will not be terminated.
*- The rate of production and the price of the product will remain the same but the cost of production at the new plant is estimated to be 20% bellow the present production cost
There is no cost for hiring the few new employees required for the new plant.
Requirement:
Please perform a complete and detailed financial analysis and make your recommendation to the management of Johnson and Smith as to which options is more advantages.