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The lease on a factory which Marylebone plc currently rents is due to expire at the end of 2025. The factory is entirely devoted in the production of Carina. The market for Carina has been declining and a decision was taken two years ago by management to not seek renewal of the lease, but to discontinue the production of Carina when the lease expires. However, at a recent meeting, management questioned whether it might be more beneficial to cease production at the end of this year, three years earlier than had originally been decided.
Sales demand for Carina are projected to be 500,000 units in 2023, 400,000 units in 2024 and 200,000 in 2025, but the marketing director believes that these figures could be increased if an advertising campaign were to be undertaken. The company has agreed a fixed cost of £2 million, payable in two equal instalments at the end of 2023 and 2024. The marketing director acknowledges that the results of the advertising campaign are uncertain, but believes that there is a 60% chance that there would be at least a 20% increase in the projected sales figures and a 40% chance that the increase in projected sales will be as high as 30%.
Carina is currently selling for £25 per unit and variable costs of the production are estimated to be 50% of the selling price. Other annual production overheads for producing Carina are currently £2 million, which includes a £400,000 administrative allocation from head office.
The rent of the factory is a £4 million a year, payable in advance. The owner of the factory will not agree to an early termination of the lease agreement, but the company has the right to sublet the factory. Management are confident of finding a tenant who will pay £3 million at the beginning of each of the three relevant years.
The plant and machinery used in the factory was all bought in January 2019 for £3 million. Were the factory to close at the end of 2022, the plant would be sold for £1.5 million, but if it were retained until 2025 it would be sold for £400,000.
When the factory closes, certain workers would be entitled to redundancy payments. These are estimated to be £800,000 if closure were to take place at the end of this year, but expected to be £550,000 (in current terms) if closure were at the end of 2025. In either case the payment would be made on the day of closure.
Production of Carina gives rise to a working capital requirement of an amount equal to 8% of the sales value. This needs to be in place by the beginning of each year concerned and at the end of the production period, all working capital will have to be released.
The selling price, rental income and all other costs above are quoted in current terms and subject to general inflation with the exception of the advertising cost, expected disposal proceeds and capital allowances.
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Reasons for Ceasing Production at the End of 2023: 1. Projected Sales: Sales demand for Carina is projected to be 500,000 units in 2023, which offers a potential for a profitable year before ceasing production. 2. Adv Thêm
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