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 net operating working capital. The tax rate is 40%. What is the initial investment outlay: The company spent and expensed R50 000 on research related to the project last year. Would this change your answer? The company plans to use a building that it owns to house the project. The building could be sold for R1 million after taxes and real estate commissions. How would that fact affect your answer?

Answer 1

Solution:-

The formula for determining the initial outlay = Initial Capital expenditure + Net working capital investment + Project expenses (net of tax) - Net cash flow from disposed asset.

Initial outlay = $ 9 Million + $ 3 million = $ 12 million.

The expenses spent on the project is added to the Initial outlay after net of tax. In that case, the amount spend my the company R50000 ($ 3311 -converted into USD) need to added to the initial outlay after net of tax.

Initial outlay = $ 12 million + $ 3311* (1-0.40)

Initial outlay = $ 12001987

The purpose of determining the initial outlay is to find out the cost for the expansion of the business. The cash inflow and outflow related the expansion of the business is only considered for determining the initial cost and not the existing cash flow or facilities. In that case, the sale proceedings of the asset which already owned by the existing business will not be considered for deduction from the Initial outlay cost spent for the expansion of business.