FORUM DESCRIPTION Your company is considering adding a new production line in order to meet increasing product demand. The investment will be financed at an interest rate of 8% compounded annually. The new line will cost $650,000 in procurement and installation. An additional $21,000 will be incurred as annual operating and maintenance (O & M) cost. Additional annual revenue by using the new line is estimated to be $112,000. If the company wants to "break-even" by investing in the extra production line in 10 years. What advice will you give the company with this investment? What could be altered to make the investment more attractive?

Explanation: Investment = $ 650000

Interest rate Initial = 8%

Operating and maintenance costs = $21000 a year

Expected revenue is = $ 112000 a year

The company wants to break even in 10 years, meaning the new plant must generate enough revenue to cover the cost incurred acquiring the new plant.

One way we can use is to treat the amount of $ 650000 as a loan and calculate yearly repayments that will make the amount of $ 650000 to be equal to zero in 10 years. We will then take that amount and compare it with the revenue that will be generated by the new plant a year. The revenue that will use to compare will be net of annual operation and maintenance cost.

   Payments = PV(r)/ (1-(1+r) ^ (-n))

    Payments =  (650000×(0+08))/(1-(1+0.08)^(-10) )

    Payments = 96869.167656 = $ 96869.17

   The payment of $ 96869.17 a year will make $ 650000 equal to zero in 10 years, we can consider this amount as the required net revenue or profit the new plant should generate to break even in 10 years.

We now consider how much profits will the new production line generate a year.

Profit a year = revenue – operating and maintenance cost

Profit a year = 112000 – 21000 = 91000

The new plant will make a profit of $91000 a year while profit require to break even in 10 years is $ 96869.17. The new production plant will make a loss of $ 5869.17 each year (96869.17 – 91000).

Forum description should not acquire the new production plant, based on the above calculation acquiring the new plant will result in a loss in investment.

The investment in the new product plant would be attractive if operating and maintenance costs could decrease or negotiate a once of payment  and also if can expected revenue increase. a decrease in maintenance costs and/or an increase in expected revenue will make this investments much more attractive.  

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