If the firm selects option 1, what is the proper cash flow amount to use as the initial investment? Show your computation.

Consider a company that has land it acquired 3 years ago at a cost of $260,000. It now wants to utilize the land for more productive purposes. It is considering two options. The first option is it can build a facility on the land for an upfront cost of $600,000. It would take 2 years to construct. Further, machinery and installation necessary to begin production would cost $790,000 which would be paid for at the start of production. Both the plant and equipment would be depreciated on a straight-line basis over the 4-year life of production, for which at the end of that time, the property and plant could be sold for $600,000 and the machinery scrapped for $150,000. Estimated sales from production would be $850,000 per year with $90,000 of that amount being variable cost. The annual fixed cost would be $25,000. The project will require $10,000 of net working capital which is recoverable at the end of the project. The firm’s discount rate for a project of this risk is 12 percent. The second option is to immediately sell the land to a buyer that is willing to pay cash of $500,000. The company’s tax rate is 34 percent.

1. If the firm selects option 1, what is the proper cash flow amount to use as the initial investment? Show your computation.

2. If the firm selects option 1, what are the proper cash flow amounts that will occur over each of the 4 years of production? Show your computations.

3. What is the net present value of option 1? Show your computations.

4. Which option should the company ultimately choose and why?