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Scenario 4.5 The T. H. King Company Has Introduced a New Product

question 4

Multiple Choice

Scenario 4.5
The T. H. King Company has introduced a new product line that requires two work centers, A and B for manufacture. Work Center A has a current capacity of 10,000 units per year, and Work Center B is capable of 12,500 units per year. This year (year 0) , sales of the new product line are expected to reach 10,000 units. Growth is projected at an additional 1,000 units each year through year 5. Pre-tax profits are expected to be $30 per unit throughout the 5-year planning period. Two alternatives are being considered:
1) Expand both Work Centers A and B at the end of year 0 to a capacity of 15,000 units per year, at a total cost for both Work Centers of $200,000;
2) Expand Work Center A at the end of year 0 to 12,500 units per year, matching Work Center B, at a cost of $100,000, then expanding both Work Centers to 15,000 units per year at the end of year 3, at an additional cost at that time of $200,000.
The King Company will not consider projects that don't show a 5th year positive net present value using a discount rate of 15%.
-Use the information in Scenario 4.5. What is the pre-tax cash flow (net present value) for alternative #1 compared to the base case of doing nothing for the next five years?

Definitions:

Taxable Bonds

Bonds whose interest payments are subject to federal, state, or local income taxes.

Exercise Price

The cost at which an option's holder may purchase (for a call option) or sell (for a put option) the base asset.

Put Option

A financial contract giving the holder the right, but not the obligation, to sell a specific amount of an underlying asset at a set price within a specified time.

Stock Split

An action by a company to divide its existing stock into multiple shares to boost the liquidity of the shares, although the overall value of the shares remains the same.