Truman Industries is considering an expansion. The necessary equipment would be

Question

Truman Industries is considering an expansion. The necessary equipment would be purchased for $18 million, and the expansion would require an additional $1 million investment in net operating working capital. The tax rate is 40%. The company spent and expensed $15,000 on research related to the project last year. Would this change your answer? Explain. No, last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. Yes, the cost of research is an incremental cash flow and should be included in the analysis. Yes, but only the tax effect of the research expenses should be included in the analysis. No, last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay. No, last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

Explanation / Answer

No, last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

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