Problem: Truman Industries is considering an expansion. The essential equipment would be bought for $16 million, and the expansion would need an additional $3 million investment in net operating working capital. The tax rate is 40%.
problem1. What is the initial investment outlay? prepare out your answer totally. For ex, 13 million must be entered as 13,000,000.
problem2. The company spent and expenditure $15,000 on research related to project previous year. Would this change your answer? Describe.
i)No, last year's expenditure is considered a sunk cost and doesn’t represent an incremental cash flow. Hence, it must not be included in analysis.
ii)Yes, the cost of research is incremental cash flow and must be included in the analysis.
iii) Yes, however only the tax effect of the research expenses must be included in analysis.
iv) No, previous year's expenditure must be treated as a terminal cash flow and dealt with at the end of the project's life. Therefore, it must not be included in initial investment outlay.
v) No, previous year's expenditure is considered an opportunity cost and doesn’t represent an incremental cash flow. Therefore, it must not be included in analysis.
problem3. The company plans to use building it owns to house the project. The building could be sold for $3 million after taxes and real estate commissions. How would which fact affect your answer?
i) The potential sale of the building represents opportunity cost of conducting the project in that building. Hence, the possible after-tax sale price must be charged against the project as cost.
ii) The potential sale of the building represents opportunity cost of conducting project in that building. Hence, the possible before-tax sale price should be charged against the project as a cost.
iii) The potential sale of the building represents an externality and therefore must not be charged against the project.
iv) The potential sale of the building represents the real option and therefore must be charged against the project.
v) The potential sale of the building represents a real option and therefore must not be charged against the project.