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Question
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 action, if any, should the King Company take?
A) Do nothing–neither alternative provides a positive net present value after five years.
B) Select Alternative #1.
C) Select alternative #2.
D) Either alternative may be selected, since the positive net present values are the same after five years.
Answer
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