2D2G LOGAN ENTERPRISES IS AT A CRITICAL DECISION POINT AND MUST DECID...

321.

CSO: 2D2a

LOS: 2D2g

Logan Enterprises is at a critical decision point and must decide whether to go out of

business or continue to operate for five more years. Logan has a labor contract with five

years remaining which calls for $1.5 million in severance pay if Logan’s plant shuts

down. The firm also has a contract to supply 150,000 units per year, at a price of $100

each, to Dill Inc. for the next five years. Dill is Logan’s only remaining customer.

Logan must pay Dill $500,000 immediately if it defaults on the contract. The plant has a

net book value of $600,000, and appraisers estimate the facility would sell for $750,000

today but would have no market value if operated for another five years. Logan’s fixed

costs are $4 million per year, and variable costs are $75 per unit. Logan’s appropriate

discount rate is 12%. Ignoring taxes, the optimal decision is to

a.

shut down because the annual cash flow is negative $250,000 per year.

b.

keep operating to avoid the severance pay of $1,500,000.

c.

shut down since the breakeven point is 160,000 units while annual sales are