The manufacture of folic acid is a competitive business. A new plant costs $100,000 and lasts for three years. The cash flow from the plant is as follows: Year-1: +43,300, Year-2:
$43,300 and Year-3 = 58,300. (Assume there is no tax.) If the salvage value at the end of year-2 is $40,000, would you scrap the plant at the end of year-2?

Question

Quizplus · Accepted Answer

To determine whether to scrap the plant at the end of year-2, we need to calculate the net present value (NPV) of the plant at the end of year-2 and compare it to the salvage value of $40,000. Using a discount rate of 10%, we can calculate the NPV as follows:

NPV = -$100,000 + $43,300/(1.1)^1 + $43,300/(1.1)^2 + $40,000/(1.1)^2
NPV = -$100,000 + $35,727 + $30,661 + $29,158
NPV = -$4,454

Since the NPV is negative, it would not be worthwhile to keep the plant for an additional year. Therefore, we should scrap the plant at the end of year-2 and sell it for its salvage value of $40,000. Thus, the answer is B.

The Manufacture of Folic Acid Is a Competitive Business