Truman Industries is considering an expansion. The necessary equipment would be

Question

Truman Industries is considering an expansion. The necessary equipment would be purchased for $18 million, and the expansion would require an additional $1 million investment in net operating working capital. The tax rate is 40%. The company plans to use a building it owns to house the project. The building could be sold for $1 million after taxes and real estate commissions. How would that fact affect your answer? 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. The potential sale of the building represents an opportunity cost of conducting the project in that building. Therefore, the possible before-tax sale price must be charged against the project as a cost. The potential sale of the building represents an externality and therefore should not be charged against the project. The potential sale of the building represents a real option and therefore should be charged against the project. The potential sale of the building represents a real option and therefore should not be charged against the project.

Explanation / Answer

a.Equipment NWC Investment Initial investment outlay b. No, last year’s $50,000 expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. c. 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. $ 8,000,000 3,000,000 $11,000,000

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