J.B. Corporation is considering the purchase of equipment that has an invoice pr
ID: 2766349 • Letter: J
Question
J.B. Corporation is considering the purchase of equipment that has an invoice price of $450,000. The equipment was recommended by a consulting firm that did an analysis for J. B. Corporation. J. B. paid the consulting firm $12,000 for its report. The cost of shipping and installation is $50, 000. The equipment will be depre4iated on a straight-line basis over its useful life of 10 years, assuming no salvage vale. The equipment will replace existing assets that have a current book value of $100,000 and which could be sold for $150,000. Additional net working capital of $15,000 will be required to maintain the equipment and to support higher sales. J.B.’s marginal tax rate is 40%. Calculate the initial outlay required to fund this project.
Explanation / Answer
In this problem, Corporation is going to buy a new equipment and replace it for an existing one. It is based on a consultants report The following data are available. You have to ascertain initial outlay required to fund this project.
1. Invoice price of new equipment is $450,000. It will be paid immediately. So it will be considered in estimating initial outlay.
2. Consultants fees of $12,000 is a sunk cost. It has been already incurred. Now it is immaterial whether firm adopts the advice of consultant or not.
3. Cost of shipping and installation is $50,000. Any cost incurred for making equipment ready for use is considered as a component of its cost. So it will be considered for initial outlay computation.
4. Depreciation of equipment is used for calculating cash flows from this replacement in coming 10 years. So it is not required for initial outlay calculation.
5. Book value of existing asset is $100,000. It will be considered in incremental cash flow calculation in coming years. It is not related with initial outlay computation.
6. This equipment is sold at $150,000. It will reduce initial fund requirement. So it should be considered here.
7. Additional working capital is also required now. So it is to be considered in calculating initial outlay.
Thus initial outlay is-
Amount 1. Cost of new equipment $450,000 2. Cost of shipping and installation $50,000 3. Total of 1 and 2 $500,000 4. Sale value of old equipment $150,000 5. Net amount required for new equipment[3-4] $350,000 6. Additional working capital $15,000 7. Initial outlay [5+6] $365,000Related Questions
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