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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Shaftel Ready Mix is a processor and supplier of concrete, aggregate, and rock products. The company operates in the intermountain western United States. Currently, Shaftel has 14 cement-processing plants and a labor force of more than 375 employees. With the exception of cement powder, all materials (e.g., aggregates and sand) are produced internally by the company. The demand for concrete and aggregates has been growing steadily nationally. In the West, the growth rate has been above the national average. Because of this growth, Shaftel has more than tripled its gross revenues over the past 10 years.

Of the intermountain states, Arizona has been experiencing the most growth. Processing plants have been added over the past several years, and the company is considering the addition of yet another plant to be located in Scottsdale. A major advantage of another plant in Arizona is the ability to operate year round, a feature not found in states such as Utah and Wyoming.

In setting up the new plant, land would have to be purchased and a small building constructed. Equipment and furniture would not need to be purchased. These items would be transferred from a plant that opened in Wyoming during the oil boom period and closed a few years after the end of that boom. However, the equipment needs some repair and modifications before it can be used. The equipment has a book value of $200,000, and the furniture has a book value of $30,000. Neither has any outside market value. Other costs, such as the installation of a silo, well, electrical hookups, and so on, will be incurred. No salvage value is expected. The summary of the initial investment costs by category is as follows:

Chapter 12, Problem 55C, Shaftel Ready Mix is a processor and supplier of concrete, aggregate, and rock products. The company , example  1

Estimates concerning the operation of the Scottsdale plant follow:

Chapter 12, Problem 55C, Shaftel Ready Mix is a processor and supplier of concrete, aggregate, and rock products. The company , example  2

After reviewing these data, Karl Flemming, vice president of operations, argued against the proposed plant. Karl was concerned because the plant would earn significantly less than the normal 8.3% return on sales. All other plants in the company were earning between 7.5 and 8.5% on sales. Karl also noted that it would take more than 5 years to recover the total initial outlay of $582,000. In the past, the company had always insisted that payback be no more than 4 years. The company’s cost of capital is 10%. Assume that there are no income taxes.

Required:

  1. 1. Prepare a variable-costing income statement for the proposed plant. Compute the ratio of net income to sales. Is Karl correct that the return on sales is significantly lower than the company average?
  2. 2. Compute the payback period for the proposed plant. Is Karl right that the payback period is greater than 4 years? Explain. Suppose you were told that the equipment being transferred from Wyoming could be sold for its book value. Would this affect your answer?
  3. 3. Compute the NPV and the IRR for the proposed plant. Would your answer be affected if you were told that the furniture and equipment could be sold for their book values? If so, repeat the analysis with this effect considered.
  4. 4. Compute the cubic yards of cement that must be sold for the new plant to break even. Using this break-even volume, compute the NPV and the IRR. Would the investment be acceptable? If so, explain why an investment that promises to do nothing more than break even can be viewed as acceptable.
  5. 5. Compute the volume of cement that must be sold for the IRR to equal the firm’s cost of capital. Using this volume, compute the firm’s expected annual income. Explain this result.

1.

To determine

Construct a variable-costing income statement for the proposed plant and calculate the ratio if net income to sales. Also state the Person K is right on return on sales being lower than the company average.

Explanation

Income Statement:

The statement that shows revenue and expenses incurred over a period of time (usually one year) is called an income statement. It is used for external financial reporting as it helps the outsiders and investors in evaluating the firm’s financial health.

The following table represents the income statement of Company SRM:

Company SRM
Income Statement
For the proposed plant
ParticularsAmount ($)Amount ($)
Sales revenue1 1,575,000
Less: Variable expenses2 1,227,800
Contribution margin 347,600
Less Fixed expenses:  
Salaries135,000 
Insurance75,000 
Telephone5,000 
Depreciation56,200 
Utilities25,000296,200
Net income 51,000

Table (1)

Therefore, the net income from the proposed project is $51,000.

Use the following formula to calculate ratio of net income to sales:

Ratioofnetincometosales=NetincomeSales

Substitute $51,000 for net income and $1,575,000 for sales in the above formula

2.

To determine

Find out payback period for the proposed plant. State that the estimation of Person K about payback period being more than 4 years is correct. State that the sale of the plant on its book value will affect the answer or not.

3.

To determine

Find out the NPV and IRR for the proposed plant. State that the sale of the plant on its book value will affect the answer or not

4.

To determine

Calculate the break-even cubic yards that must be sold. Calculate NPV and IRR with the help of break-even volume. State whether the investment is acceptable or not. Explain the reason of accepting an investment that promises earn only break-even.

5.

To determine

Calculate the volume of cement at which IRR equals firm’s cost of capital. Calculate the firm’s expected annual income using the calculated volume. Explain the answer.

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