A company will initially outsource its electric scooter parts. But manufacturing these parts in-house beginning in 2016 will imply changes to an existing factory. This factory cost €7 million three years ago and had an estimated useful life of 10 years. Fromm is evaluating two scenarios:
Scenario 1: Sell the existing factory for €5 million. Build a new factory costing €30 million with a useful life of 10 years.
Scenario 2: Refit the existing factory for €27 million.
Fromm’s estimate of growth capital expenditure included in the company’s property, plant, and equipment under Scenario 2 should be:
A. lower than under Scenario 1. B. the same as under Scenario 1. C. higher than under Scenario 1.
The answer is C. This is the book’s explanation. In Scenario 2, growth capital expenditure of €27 million for the refit of the existing idle factory is higher than the growth capital expenditure in Scenario 1 of €25 million. The €25 million is the cost of building a new factory for €30 million less the proceeds from the sale of the existing idle factory of €5 million.
Can someone please explain better than the book on why the answer is C. For Scenario 2, I don’t understand how the entire 27 million can be considered ‘growth’ capital expenditure. Shouldn’t growth capital expenditure be 27 million minus the depreciation in the three years of the old asset? Please help. Thank you!