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Tannen Industries is considering an expansion. The necessary equipment would be purchased for $13 million and will be fully depreciated at the time of purchase, and the expansion would require an additional $4 million investment in net operating working capital. The tax rate is 25%.
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Answer for Question (a)
The necessary equipment would be purchased for $13 million and will be fully depreciated at the time of purchase, and the expansion would require an additional $4 million investment in net operating working capital. The tax rate is 25%.
Equipment Cost : Outflow: $13000000, Initial Net working Capital investment : Outflow : $ 4000000; Bonus Depreciation 100%: $ 13000000: Tax savings/shield on depreciation @ 25%: Inflow : 3250000
Net Initial Cash flow: -13000000 -4000000 + 3250000 = Net Initial Cash OUTFLOW of $13750000 or $ 13.75 Million
Answer for Question (c)
The company spent and expensed $10,000 on research related to the project last year.
Answer I: No, last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
The expense which is already spent should not be considered in the initial year or either any of the future projections of the cash flows, as they dont impact the current or future cash flows of the specified project.
Answer for Question (e)
Suppose the company plans to use a building that it owns to house the project. The building could be sold for $4 million after taxes and real estate commissions.
Answer I: The potential sale of the building represents an opportunity cost of conducting the project in that building. Therefore, the possible after-tax sale price must be charged against the project as a cost.
As mentioned, if not used for this project, the building could have been sold for $4 million and hence, it is evident that this opportunity is lost; Hence, this should be considered as Loss of Opportunity or the Oppotunity cost. Hence, the same (after tax price) need to be considered in the project cost sheet.