Project Description

Orange Computers has transformed into one of the largest smartphone companies in the

world. Based on recent changes to the federal tax code, building phones in the US has

become more attractive. Orange wants to build a single factory in either Pennsylvania,

Texas, or North Carolina. Each state is offering incentives to woo Orange. Pennsylvania

and North Carolina propose that Orange build a new facility, while Texas is offering grants

to help Orange renovate a recently closed factory.

Build a workbook to calculate the weighted average cost of capital (WACC), net present

value (NPV) and internal rate of return (IRR) for each location over ten years using the

information provided. Determine where Orange should locate their factory and give a brief

explanation of why.

Below are the pieces of information necessary to calculate the WACC, NPV, and IRR:

1. The factories in Pennsylvania and North Carolina could produce and sell 20 million

phones annually, while the Texas factory could produce and sell 12 million.

2. Orange can sell all the phones produced at an average of $400 per phone in Year

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. Orange forecasts that they can gradually raise the price of their phones by 2%

per year over the next 10 years. A new factory would be 5 million square feet at a cost of $160/ft to build in

Pennsylvania or North Carolina. After grants, Orange would only need to pay

$125/ft to renovate the existing 3 million square foot factory in Texas.

4. North Carolina will lease publicly owned land for the factory to Orange tax free, but

the local government won’t waive the 1% annual property tax which is calculated

on the initial cost of the factory. The land in Pennsylvania will cost $20 million, and

with the local property tax of 0.5%, property tax in Pennsylvania is calculated based

on the initial cost of the factory plus the cost of the land. Since there is an existing

factory in Texas, there will be no cost for purchasing the land, and the state has

agreed to pay the local property tax for 10 years.

5. Orange plans to spend $500 million on equipment for the new factories in North

Carolina or Pennsylvania. Texas is offering to help pay for the equipment which

lowers the cost to $300 million, but it has added a caveat that forces Orange to sell

the equipment to the state when Orange disposes of the equipment after 10 years.

The estimated proceeds on the sale of the equipment is presented in the template

for each location. Note, do not use “proceeds on equipment sale” as “salvage value”

when calculating depreciation. Use the “proceeds on equipment sale” in calculating

the gain or loss on the equipment sale.

6. Orange can depreciate 100% of the cost of equipment when it’s put into service for

tax purposes2 or it can depreciate the equipment on a straight-line basis with a

useful life of 10 years. Factory cost must be depreciated over 15 years on a

straight-line basis. There is no salvage value to consider for either the equipment or

the factory. Also recall that there is no depreciation on land.

7. The federal income tax rate for Orange is 21%. In their pursuit of new

manufacturing jobs, all three states have offered different incentive packages that

result in a state income tax equivalent to 3% for the first 10 years. State income

tax is deductible when calculating federal taxes.

8. Orange plans on hiring 8,000 workers in Pennsylvania or North Carolina with a total

annual expense of $80,000 per worker. The factory in Texas would require 5,000

workers at $90,000 per year. Wage inflation is forecasted to be 5% per year in

North Carolina, 4% in Pennsylvania, and 3% in Texas.

9. For operational expenses, assume that fixed overhead will be 10% of annual sales

and cost of goods sold will be 60% of annual sales at each factory. Labor costs will

be calculated separately using the inputs applicable for each location, (note number

8 information above). Orange will also need to maintain a total of 10% of next year’s sales in working capital. In other words, this is the cash that Orange will

have to reserve for this project. It cannot be used elsewhere in the company.3

10.Orange keeps a stable debt-to-equity ratio of 0.8 and will use the same mix of debt

and equity to finance this project. The average interest rate on its debt is only 3%,

but its required rate of return on equity is 35%. Your calculation for WACC must be

presented in cell B32. Note that interest expense is not included in operating

income as the interest rate will impact the WACC. Including interest expense in

calculating operating income will double-count the effect of interest on the project.

Also, note that interest expense is considered a non-operating expense and hence

would not be included in calculating operating income.