Question

Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $20 million, and production and sales will require an initial $5 million investment in net operating working capital. The company's tax rate is 40%.

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 new project last year. Would this change your answer?
   -Select- Yes or No
   
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, decrease , or not change

Answer 1

Solution:-

A. To Calculate initial investment outlay-

Initial Investment Outlay = Equipment Cost + Working Capital

Initial Investment Outlay = $2,00,00,000 + $5,000,000

Initial Investment Outlay = $2,50,00,000

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

No, The Answer is remains same as this is sunk cost. Past cash flows and past investment are not relevant. Sunk cost is a cost which can not affect the users decision making.

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-

If we can not sale the building this represents the Oppourtunity loss for the company. So, this will be added with the initial investment of the project.

Total Investment Outlay = Initial Investment Outlay + Oppourtunity Loss

Total Investment Outlay = $2,50,00,000 + $15,00,000

Total Investment Outlay = $2,65,00,000

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