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Food Industry's Return
on Investment Guidelines
For Companies Evaluating
Private vs. Public Warehousing |
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Information Needed to Calculate Worksheet #2 (NPV)
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| 1. |
The Period over Which to Perform the
Analysis.
This may cover the entire useful life of the private warehouse
option, or some shorter period of time. A shorter period will be
relevant if your company has a shorter investment horizon, or if
there is some uncertainty about costs after a certain point in time.
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| 2. |
Required Rate of Return.
This rate should reflect the time value of money and the risk of the
cash flows of the two options. Management should use their judgment
in arriving at the required rate of return. Since greater risk is
attached to capital investments than to a bank loan, the rate is
usually above the interest rate at which banks are lending money.
After a company’s required rate of return is estimated, the present
value method can be applied to discount the cash flows to the
present.
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| 3. |
The Relevant Annual Cash Flows.
Document the annual cash flows for both the public and private
options separately so as to consider the tax implications of each
option. Cash flows for each project should be measured on an after
tax basis. In addition to statutory tax rates, three things affect
the company’s taxes; revenues, expenses, and timing of recognition
of those revenues and expenses for tax purposes. The present value
of taxes paid is less on a revenue item the further into the future
that the tax payment actually occurs. Similarly, the present value
of taxes saved is greater on an expense item the sooner the
reduction in taxes paid actually occurs. The most common discrepancy
between cash flow timing and tax recognition concerns depreciation.
Because depreciation is included in expenses, it affects the timing
of tax payments. Remember that cash is expended upon acquisition of
a capital asset. Consequently, depreciation is not a cash expense.
However, the tax deduction associated with depreciation reduces the
annual cash outflows.
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a. |
Private
Warehouse:
For simplicity purposes, Worksheet #2 assumes that all capital
expenditures are incurred in the first year, and operating expenses
are incurred equally over the time period selected by you to perform
the analysis. In performing a more detailed analysis using your own
worksheet, you should consider the additional costs unique to a
refrigerated warehouse. Construction of your own warehouse involves
initial cash flows from the capital investment, followed by cash
flows from operating activities. Also consider capital costs for
each year that such costs will be incurred should they not all be
incurred in year one, the cash inflow (net of tax), of a gain on
sale of the asset, salvage value or market value in the final year.
Operating expenses of your private warehouse option should be
converted to cash flows net of tax for each year of operation.
Consider unique start up costs in the early years, and additional
costs associated with closing down the facility at the end of its
useful life. Also consider fixed costs of your private facility that
may be only part time based on seasonal fluctuations. |
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b. |
Public
Warehouse:
To identify the cash flows associated with the use of a public
warehouse facility, contact your local public warehouseman as
discussed elsewhere in this kit. Be sure to include the cost of
transportation to and from the warehouse, and consider the related
tax deduction that you will obtain by expensing the costs related to
the use of the public facility.
The following public warehouse
operating factors should contribute to a reduction of expenses:
- Lessens the impact, and costs,
of seasonal fluctuations in inventory as expenses are generally
incurred in relationship to product storage.
- Provides flexibility to both
grow and adapt to changing circumstances.
- Cost savings may be realized
through consolidation of shipments with various other users.
- A full menu of public warehouse
services provides you with the flexibility of selecting only those
services needed for your products.
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