1. Truman Industries is considering an expansion. The necessary equipment would
ID: 2812111 • Letter: 1
Question
1. Truman Industries is considering an expansion. The necessary equipment would be purchased for $12. The expansion would require an additional $2 investment in net operating working capital. The company spent and expensed $3 on research related to the project last year. The company plans to use a building that it owns to house the project. The building could be sold for $6 after taxes and real estate commissions. What is the initial investment outlay?
2. KTS is trying to estimate the first-year operating cash flow. The financial staff has given you the following information:
Incremental revenue = $8
Depreciation = $2
Interest Expense = $1
Marginal tax rate = 50%
What is the operating cash flow in year 1?
a. 3
b. 2.5
c. 5
Explanation / Answer
1. Initial investment:
a. Cost of new equipment = $12
b. Additional investment = $ 2
Initial investment = (a +b) =$ 14
The research expense need not be included in initial investment as it a cost incurred in the past ie., a sunk cost therefore irrelevant in analysis.
Since the building is sold for housing the project, it's opportunity cost should be included in the cost of project. The after tax sale price should be included in cost of project.
2. To ascertain operating cash flow not he basis of given information you need to add back depreciation to the incremental revenue(depreciation being non cash item) reduce tax.
Operating cash flow = (8+2) - 50% = $5
Interest expense should be considered only while calculating cash flows from financing activities.
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