Porter Climate Control is evaluating a proposal to move some manufacturing operations from an obsolescent plant in Illinois to a new facility in Mexico. The new facility will cost $58 million to open. and is expected to result in savings of $16 million per year for the first five years. At the end of 5 years, Porter will decide either to close the plant in Mexico or to keep it indefinitely. If Porter closes the plant, the building and equipment can be sold for $20,000,000. If the plant is kept, assume that the $16 million turns into a perpetuity. There is a 30% chance the plant will be closed and a 70% chance it will be kept. Compute the expected NPV of the project. Use a discount rate of 12%.
A) $75.32 million
B) ($30.32 million)
C) $56.04 million
D) $114.04 million

Question

Quizplus · Accepted Answer

To calculate the expected NPV, we need to find the probability-weighted NPV of each possible outcome.

Option 1: Close the Plant in 5 years
Initial cost = -$58 million
Savings for 5 years = +$16 million per year = +$80 million
Sale of building and equipment = +$20 million
NPV = -$58 million + $80 million + $20 million / (1.12)^5 = $69.96 million

Option 2: Keep the plant indefinitely
Initial cost = -$58 million
Savings perpetuity = +$16 million / 0.12 = +$133.3 million
Probability of keeping the plant = 0.7
NPV = -$58 million + $133.3 million * 0.7 / (1.12)^5 = $53.08 million

Expected NPV = 0.3 * $69.96 million + 0.7 * $53.08 million = $56.04 million

Therefore, the best choice is to move manufacturing operations to Mexico.

Porter Climate Control Is Evaluating a Proposal to Move Some