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Over the last five years, the Billagong Company has spent $25 million developing a new product, called bings. It is considering whether to build a plant in California that will manufacture bings. The current date is 12/31/2000. The cost of the plant is $10M to be paid today. It will take one year to build. The plant will start producing on 1/1/2002 and the first revenues and costs will be received and paid on 12/31/2002. The plant is expected to produce for three years. It will produce 3 million bings per year. The plant will be depreciated over the three years it is in production to zero, and it has no salvage value. The company can sell each bing for $5 and the raw materials will cost $2 per bing in all three years bings are produced. The total labor costs will be $1.5M each year the plant is operational.
The land the plant will be built on could be rented out for $500K per year with the rent being paid each year at the end of each year, not including today (i.e., on 12/31/2001, 2002, 2003, and 2004).
The firm uses straight-line depreciation and has a tax rate of 35 percent. The appropriate discount rate is 10%. For now, assume that there are no working capital requirements.
What is the projected operating cash flow (OCF) for each of the three years the plant will be operational?
Identify factors that may influence the choice of measurement approach. Discuss how the measurement approach adopted impacts on the quality of accounting information produced.
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