Trout Corporation: Capital Budgeting

The Trout Corporation is a manufacturer of building materials located in Dennison, Texas. Trout is currently planning to begin producing aluminum siding in a vacant manufacturing facility on the North side of Dennison. Although the vacant facility has no conceivable alternative use, it is carried on Trout’s books at its historical cost of $800,000. The equipment required for the production of aluminum siding will cost $4 million and is expected to have a useful life of 10 years. The Internal Revenue Service allows this equipment be depreciated to a zero salvage value using straight-line depreciation. Sales are expected to be $1,800,000 per year during each of the next 10 years. The variable costs of production are expected to be 50 percent of sales. Although the project will not require any inventories, the chief financial officer estimates that working capital will be required to support the accounts receivable generated by the sales of aluminum siding. The standard for receivables turnover in the aluminum siding industry is 3 times per year. Trout has an opportunity cost of capital of 12 percent and a corporate tax rate of 35 percent. Assuming that Trout expects that there will be absolutely no demand for aluminum siding at the end of 10 years, determine whether the firm should enter the aluminum siding business.