Slaughter House Five, Inc. operates several feedlots, one of which is located in Tombstone. The Tombstone feedlot no longer produces a profit because of its distance from sources of feed, relatively high transportation costs, and a lack of modern facilities. As a result, management is considering the possibility of constructing a new feedlot in Tumbleweed to replace the Tombstone lot.
The new feedlot would be close to a feed source and near meat packers. If the Tumbleweed lot were to be built, the Tombstone lot would be closed down. The company president favors making the move for various reasons, but several directors have asked for more detailed information before approving the decision. Their main concern is that abandoning the Tombstone lot would create a large loss.
You are asked to analyze the proposal and to provide information to help the directors decide whether to support the president's desire to move to Tumbleweed. Here's the Catch22 - you work for the president and she doesn't care about the quantitative information. She operates on gut instincts which, in the past, have proven very successful. She makes it very clear to you that your career with the company depends on whether or not you're a "team player" (i.e. whether or not you make the numbers come out to support her recommendation).
You have an unemployable spouse, two young kids in diapers, a dog who eats as much as your entire family combined, a HUGE mortgage, car loans, college loans, and you support your lousy spouses' mother who lives in your attic. To top things off, there is a world-wide recession, and there are no jobs available within your trained profession. The alternative is to work at the local fertilizer company employed as a manual manure spreader. This would reduce your salary to one-fourth what you are currently making. Should this happen, you will lose the house, your spouse will stay with you (bummer!), your kids will starve, and your spouses' mother will have to walk on one leg 5 miles DOWNHILL both ways in order to get to the store to buy her cigarettes. (Sorry, I took a little time to digress here so that you would get the full picture of how important it is for you to keep your job.!!)
The president provides you with the following data, indicating that it was arrived at in as objective of manner as possible:
Loss from abandoning the Tombstone lot - The land and facilities of the Tombstone lot have a $1 million book value. Virtually none of the machinery or other assets can be sold, and the land is not suitable for any other use without prohibitive reclamation costs. Based on the price predicted by the company's independent real estate consultant, only $100,000 cash would be received through the sale of the land and the facilities. The $900,000 loss from this sale is standing between the directors and their support for the president.
Investment in the new lot - The Tumbleweed feedlot would have an up-front total cost of $5 million. In addition to being closer to feed sources and cattle buyers, this feedlot would double the capacity of the Tombstone lot. Management estimates that 100,000 head of cattle could be handled every year.
Comparative costs - At their full capacity volumes of 50,000 and 100,000 head, the cost per head at the old lot and predicted cost per head at the new lot are as follows:
Variable Costs - Tombstone, $88 per head Tumbleweed, $72 per head
Depreciation (fixed cost) - Tombstone, $2 per head Tumbleweed, $5 per head
Assume that both feedlots can operate for 10 years and the revenue per head is $77 under both scenarios.
The corporation is subject to 30% income taxes. It will not be possible to operate both the Tombstone and Tumbleweed lots. As a reflection of the high risk that they perceive, the directors want to have at least a 20% return on any investment that the company would make in the new Tumbleweed feedlot.
Required:
1. Use the net present value method to analyze the data. Present any pertinent schedules needed to produce the data with your analysis. Which feedlot location should be selected by the company?
2. Assume that data supports keeping the Tombstone lot. What would you recommend then, and why?