Question: Jo Brown�s nursery operation has grown from a sm…

Jo Brown�s nursery operation has grown from a small herb plot into a thriving nursery
business. There are 10 full-time employees and 20 seasonal (part-time) employees. For the
last three years taxable income for Brown�s Nursery has been steady at $350,000 per year.
While Jo is pleased with the current success of the nursery, she is considering a new
contract to supply a local grocery chain with fresh herbs year round. The grocery chain�s
current supplier is retiring in a year and is planning to sell his business to one of the other
grocery chains he also supplies. Rather than assigning a large portion of her current capacity
to this contract, she is considering expanding production. Jo has been offered a 5-year
contract, starting in 1 year.
To service this new contract without reducing current operations requires purchasing an
adjacent piece of land and constructing additional greenhouse space. The property can be
purchased for $200,000. The most economical solution to the greenhouse addition is to
construct two modular greenhouses for $70,000 each. The modular greenhouses have a useful
life of 12 years and a $5000 salvage value. Startup expenses are expected to be $22,500. The
purchase of the land, construction of the greenhouses, and startup are projected to require one
year. Incremental working capital for this project is $90,000 beginning with startup.
Sales from the contract are forecast at $380,000 each year. Variable costs are estimated at
$250,000 the first year, and Jo believes they will decrease at the rate of $5000 per year, as
they become expert in growing the new items in the new greenhouses. Case 36 Brown�s Nursery Part A
167
Incremental variable overhead for the new space is expected to be $30,000 per year but
when the total overhead is re-allocated (based on square feet under glass) the new production
will be charged $45,000 per year.
Upon completion of the 5-year contract, Jo believes she can either obtain another contract
from this customer, obtain a similar contract from another grocery chain, use the project�s
assets to meet increased demand for herbs from current customers of the original operation,
or dispose of the project�s assets. She believes the land can be sold for what was paid for it
and each greenhouse is expected to have a market value of $40,000 at the end of the 5-year
contract. This decision will be made early enough in the fifth year of the contract to dispose
of the project�s assets in that year.
The state tax rate is 11%. Jo uses an after-tax MARR of 12%.

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