1. Raven Industries is considering launching a new product. The new manufacturin

Question

1. Raven Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $5 million investment in net operating working capital. The company's tax rate is 40%. (a) What is the initial investment outlay? (b) The company spent and expensed $150,000 on research related to the new product last year. Would this change your answer Explain. (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? 2. The financial staff of Carrier Communications has identified the following information for the first year of the roll-out of its new proposed service: Projected Sales S18 million Operating costs (not including depreciation) $9 million Depreciation $4 million S3 million Interest expense The company faces 40% tax rate. What is the project's operating cash flow for the first year (t-1)?

Explanation / Answer

1.

Part A)

The initial investment outlay can be calculated with the use of following formula:

Initial Investment Outlay = -Manufacturing Equipment Cost - Investment in Working Capital

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Using the information provided in the question, we get,

Initial Investment Outlay = -17,000,000 - 5,000,000 = -$22,000,000

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Part B)

No, there will be no change in the answer as the amount spent on the research and development in the prior years will be treated as sunk cost which cannot be recovered in the future.

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Part C)

If the building is sold, the company can adjust the after-tax proceeds realized from the sale to the investment made. That is the total amount of investment (calculated in Part A) will get reduced by the amount of $1,500,000 (as this amount is after the adjustment of taxes and real estate commissions).

The initial investment outlay would therefore be $20,500,000.

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2.

The operating cash flow can be calculated with the use of following formula:

Operating Cash Flow = (Sales - Operating Costs - Depreciation)*(1-Tax Rate) + Depreciation

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Using the information provided in the question, we get,

Operating Cash Flow (t=1) = (18,000,000 - 9,000,000 - 4,000,000)*(1-40%) + 4,000,000 = $7,000,000 (answer)

Interest expense is not to be considered in the calculation of operating cash flow.

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