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currently employed by another division will be transferred to this project. The
other division has no alternative use for them, but they are covered by a union
contract which will prevent them from being fired for 3 years (during which they
would be paid their current salary).
(b) The project will use excess capacity in the current packaging plant. While this
excess capacity has no alternative use now, it is estimated that the firm will have
to invest $ 250,000 in a new packaging plant in year 4 as a consequence of this
project using up excess capacity (instead of year 8 as originally planned).
(c) The project will use a van currently owned by the firm. While the van is not
currently being used, it can be rented out for $ 3000 a year for 5 years. The book
value of the van is $10,000 and it is being depreciated straight line (with 5 years
remaining for depreciation).
The discount rate to be used for this project is 10%.
a. What (if any) is the opportunity cost associated with using the two employees from
another division?
b. What, if any, is the opportunity cost associated with the use of excess capacity of the
packaging plant?
c. What, if any, is the opportunity cost associated with the use of the van ?
d. What is the after-tax operating cashflow each year on this project?
e. What is the net present value of this project?
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20. Your company is considering producing a new product. You have a production
facility that is currently used to only 50% of capacity, and you plan to use some of the
excess capacity for the new product. The production facility cost $50 million 5 years
ago when it was built and is being depreciated straight line over 25 years (in real dollars,
assume that this cost will stay constant over time).
Product line Capacity used Growth rate/year Revenues Fixed Variable
currently currently Cost/Yr Cost/Yr
Old product 50% 5%/year 100 mil 25 mil 50 mil/yr
New product 30% 10%/year 80 mil 20 mil 44 mil/yr
The new product has a life of 10 years, the tax rate is 40%, and the appropriate discount
rate (real) is 10%.
a. If you take on this project, when would you run out of capacity?
b. When you run out of capacity, what would you lose if you chose to cut back
production (in present value after-tax dollars)? (You have to decide which product you
are going to cut back production on.)
c. What would the opportunity cost to be assigned to this new product be if you chose to
build a new facility when you run out of capacity instead of cutting back on production?

21. You are an analyst for a sporting goods corporation that is considering a new project
that will take advantage of excess capacity in an existing plant. The plant has a capacity
to produce 50000 tennis racquets, but only 25,000 are being produced currently though
sales of the rackets are increasing 10% a year. You want to use some of the remaining
capacity to manufacture 20,000 squash rackets each year for the next 10 years (which
will use up 40% of the total capacity), and this market is assumed to be stable (no
growth). An average tennis racquet sells for $100 and costs $40 to make. The tax rate for
the corporation is 40%, and the discount rate is 10%. Is there an opportunity cost
involved? If so, how much is it?

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