Selling the plant would cause immediate cash inflow of $4,000,000 and $6,000,000 loss from employee termination. While this does net in a $2,000,000 loss, this option results in the highest net present value for Wriston Manufacturing. In this option the Detroit products are segmented into three groups and redistributed to other factories. Group 1 products are sent to Lancaster, and Group 2 products are sent to Lima, while Group 3 products are terminated. This plan yields a net present value of $24,595 million. We assume that both plants will operate for 20 years and will be sold in their last years of operation. The terminal value of the sale of the Lancaster factory would be $13,568. We take 4,000,000 as the terminal value of the Detroit factory multiplying it by 2 assuming that our factory will be sold in 20 years instead of 77 and that the highest amount of depreciation will occur in the first 50 years. After that we compare all the factories in terms of their capacity with the Detroit factory and calculated the ratio of capacity between the factories. After that we used the discount factor of 0.8 as we assume that a factory twice as big would not cost twice as much. We do the same calculations for the Lima factory, which results in a terminal value of $7,680.
Given the nature of factory operations, we need to recognize the current underutilization of the Lancaster and Lima factories. If we transfer our production to more specialized facilities, we can be more efficient with our production as well as solve the problem of under-utilization in factories where it exists. While it is true that transferring the Group 2 products to Saginaw would result in a higher NPV than transferring to Lima as we recommend, we also note that Saginaw was already utilizing $94.2 million of its $100 million capacity. Adding additional strain to this factory could cause operation problems such as overworked workers, therefore it is best to transfer the Group 2 products to the Lima plant, which is only utilizing $12 million of its $60 million capacity. In additional consideration, we recognize that since the majority of Wriston factories are close to the Detroit plant, the customers who acquire their product from the Detroit plant will still be able to purchase their product, upon plant close and redistribution of product.
Assessment of Option 2: Build a New “Detroit” Plant
This option results in a $36 million outflow for initial plant construction and startup costs (plant construction: $30 million + $6 million), as well as a $4 million inflow from the sale of the old plant. It yields a NPV of $-5.38 million from $3 million annual cash inflows. The terminal value for year 20 when the factory will be sold is based on the terminal value of the Detroit factory because we assume that the factories are identical in structure. We calculate terminal value through multiplying $4,000,000 by 2 assuming that our factory will be sold in 20 years instead of 77 and that the highest amount of depreciation will occur in the first 50 years.
This option does render certain benefits such as we are able to keep our old employees and avoid termination costs ($6 million) and the inefficiency of our labor force. However, we would still be producing the same diverse product line and struggle with the complex and ideally inefficient nature of our operation. Additionally, we will still run the high risk of employee union pressures forcing an employment guarantee in our projected horizon (20 years).
Assessment of Option 3: Retooling Detroit Factory (Continue Operations 5-10 years)
This option is initially appealing because it does not involve an initial investment. However, it does entail $2 million investment once a year for factory retooling and maintenance. Even with the annual investment, we would continue current trends (losses of $928,000/yr). This option yields a net present value of $-11.1 million (for 5 years projection) OR $-17.99 million (10 years projection).
Although this seems unappealing, there are a few benefits to this option in that we retain our employees and 100% of our customers. Overall, however, these benefits do not outweigh the financial losses and the high risk of employee union pressures in the horizon of 5 to 10 years.
Conclusion: We should go with Option 1. While we will have to terminate employees, which will cost us $6 million, segmenting our products across under-utilized factories will increase productivity and efficiency in our product line therefore resulting in a higher NPV and future revenues.