Question

Marston Manufacturing Company is considering a project that requires an investment in new equipment of $3,200,000, with an additional $160,000 in shipping and installation costs. Marston estimates that its accounts receivable and inventories need to increase by $640,000 to support the new project, some of which is financed by a $256,000 increase in spontaneous liabilities (accounts payable and accruals). The total cost of Marston's new equipment is and consists of the price of the new equipment plus the In contrast, Marston's initial investment outlay is Suppose Marston's new equipment is expected to sell for $200,000 at the end of its four-year useful life, and at the same time, the firm expects to recover all of its net operating working capital investment. The company chose to use straight-line depreciation, and the new equipment was fully depreciated by the end of its useful life. If the firm's tax rate is 40%, what is the project's total termination cash flow? $120,000 $200,000 $504,000 $464,000

Answer 1

Compute the total cost of new equipment, using the equation as shown below:

Total cost = Purchase cost + Installation and shipping cost

                 = $3,200,000 + $160,000

                 = $3,360,000

Hence, the total cost of the new equipment is $3,360,000.

Compute the increase in the working capital, using the equation as shown below:

Increase in working capital = Increase in receivables – Increase in current liabilities

                                            = $640,000 - $256,000

                                            = $384,000

Hence, the increase in the working capital is $384,000.   

Compute the initial investment/ outlay, using the equation as shown below:

Initial investment = Cost of new equipment + Increase in working capital

                            = $3,360,000 + $384,000

                             = $3,744,000

Hence, the initial investment is $3,744,000.

Compute the tax on the sale of equipment, using the equation as shown below:

Tax = (Selling price of equipment – Book value of equipment)*Tax rate

       = ($200,000 - $0)*40%

       = $80,000

Hence, the tax on the sale of equipment is $80,000.

Compute the terminal cash flows from the project, using the equation as shown below:

Terminal cash flow = Equipment sale – Tax on sale of equipment + Working capital recovery

                                = $200,000 - $80,000 + $384,000

                                = $504,000

Hence, the terminal cash flow is $504,000.