Question

Investment Outlay

Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $19 million, and production and sales will require an initial $4 million investment in net operating working capital. The company's tax rate is 30%.

1. What is the initial investment outlay? Write out your answer completely. For example, 2 million should be entered as 2,000,000.
   $   
   
2. The company spent and expensed $150,000 on research related to the project last year. Would this change your answer?
   -Select-Yes No Item 2
   
3. Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. How would this affect your answer?
   The project's cost will -Select-increase decreasenot changeItem 3.

Answer 1

Solution a) Calculation of Initial Investment Outlay:

	$
Cost of New Manufacturing Equipment	1,90,00,000.00
Additional Operating Working Capital	40,00,000.00
Initial Investment Outlay	2,30,00,000.00

Solution b)

The company spent and expensed $150,000 on research related to the project last year. Would this change your answer.

No, this will not change the answer

The research and development costs should not be considered while calculating Initial Investment Outlay. The costs of research and development undertaken on the product are sunk costs and should not be included in the evaluation of the project. Decisions made and costs incurred in the past cannot be changed. They should not affect the decision to accept or reject the project. Hence, the project cost will remain the same.

Solution c) Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. How would this affect your answer?

As the Building has already been constructed the expenditure has already occurred, it is a sunk cost and will not be considered while calculating Initial Investment Outlay.

Hence, the Project cost will not change.