A company is setting up a new manufacturing plant to produce garden tools. a com

Question

A company is setting up a new manufacturing plant to produce garden tools. a company bought some land six years a go for $ 6 million anticipation of using it as a warehouse and distribution site, but the company decide to rent these facilities from a competitor instead. if the land were sold today,would be 6.4 million. The company wants to build its new manufacturing plant on this land; The will cost $ 14.2 million to build and the site requires $890,000 worth of grading before its suitable. what is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? why?

Explanation / Answer

Initial Investment in Fixed assets will be $14.2M in P&M + $6M in Land + $0.89M in grading = $21.09M Rationale is that Fixed assets which are used for manufacturing - will be depreicated over useful life of asset. Land is not a depreciable asset. On tyhe other hand, Land value increases with time as can be seen that it has increased from $6M to $6.4M in 6 yrs. The amount of $890,000 which is spent on grading is also part of Initial inevstment. A chklist is provided below for clarity Common Items Included in the Acquisition Cost of Property, Plant, and Equipment _______________________________________________________________________ Land -- Capitalization of land costs include the following -- all of which are not subject to tax & depreciation: * Purchase price * Commissions, permits, or fees paid by the buyer * Closing costs * Cost of real estate surveys * Special assessments for local improvements (e.g., such as pavements, street lights, sewers, and drainage systems) * Cost necessary to prepare land for its intended use (e.g., grading, filling, draining, and clearing) Land Improvements -- Capitalization of land improvement costs include the following -- all of which are subject to tax depreciation: * Paving * Fencing * Landscaping * Outdoor lighting Buildings -- Capitalization of building costs include the following -- all of which are subject to tax depreciation: * Purchase price of an existing building (old or new), or construction costs from excavation to completion * Expenses incurred in remodeling or altering a purchased building to prepare it for its intended use * Professional fees (e.g., architectural, engineering, and legal costs) and construction permits Machinery and Equipment -- Capitalization of machinery and equipment costs include the following -- all of which are subject to tax depreciation: * Purchase price * Shipping costs (e.g., freight, import duties, handling charges and insurance on the equipment while it is in transit) * Sales, use and other taxes imposed on the purchase * Installation costs, including special foundations or plant modifications * Reconditioning (used equipment) and testing for use (used and new equipment)

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