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 $9 million, and the expansion would require an additional $3 million investment in working capital. The tax rate is 40%.

a. What is the initial investment outlay?
b. The company spent and expensed $50,000 on research related to the project last year. Would this change your answer? Explain.
c. The company plans to use another building that it owns to house the project. The building could be sold for $1 million after taxes and real estate commissions. How would that fact affect your answer?

Explanation / Answer

a. Equipment                          $ 9,000,000

NOWC Investment                    3,000,000

Initial investment outlay        $12,000,000

b. No, last year’s $50,000 expenditure is considered a sunk cost and does not represent

an incremental cash flow. Hence, it should not be included in the analysis.

c. The potential sale of the building represents an opportunity cost of conducting the project in that building. Therefore, the possible after-tax sale price must be charged against the project as a cost.

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