Question

Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $10 million, and production and sales will require an initial $5 million investment in net operating working capital. The company's tax rate is 35%.

What is the initial investment outlay? Write out your answer completely. For example, 2 million should be entered as 2,000,000.

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

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?

Answer 1

1) Total investment outlay = Cost of equipment + Net operating working capital
Total investment outlay = 10,000,000 + 5,000,000
Total investment outlay = 15,000,000
The total investment outlay for manufacturing equipment is $15,000,000
2) The amount spent on research last year is a sunk costs which are cost incurred in past.
Therefore these costs are not relevant and will not be included in the investment outlay
Hence, the investment outlay will not change and remain at $15,000,000
3) The $1.50 million represents the opportunity costs which is when one income is foregone for another alternative.
This is relevant costs for investment in manufacturing equipment and therefore should be considered.
Investment outlay = $15,000,000+150,000
Investment outlay = $15,000,000+1,500,000
Investment outlay = $16,500,000
The total investment outlay for manufacturing equipment would be $16,500,000