Calculate the initial outlay required to fund the following project: The firm is

Question

Calculate the initial outlay required to fund the following project: The firm is considering the purchase of equipment that has an invoice price of $450,000. The cost of shipping and installation is $50,000. The new equipment will replace existing assets that have a current book value of $100,000 and could be sold for $150,000. Additional new working capital of $15,000 will be required to maintain the new equipment and support higher sales. The firm's marginal tax rate is 40%.

Explain what is and is not considered to calculate the initial outlay and why

Explanation / Answer

Book value = $100,000

Market value = $150,000

Tax rate = 40%

After tax proceed from sale of existing Equipment is calculated below:

Proceeds from sale = $150,000 – [($150,000 - $100,000) ×40%]

                           = $150,000 – $20,000

                           = $130,000

Hence, Proceed from sale of existing Equipment is $130,000.

Purchase price of new equipment = $450,000

Installation cost = $50,000

Initial working capital = $150,000

Realize amount from sale of existing machine = $130,000

Initial investment amount in project = $450,000 + $50,000 + $15,000 - $130,000

                                                           = $385,000.

Hence, Initial investment amount in project is $385,000.

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