Tannen Industries is considering an expansion. The necessary REQUIRED INVESTMENT

Question

Tannen Industries is considering an expansion. The necessary REQUIRED INVESTMENT equipment would be purchased for $18 million, and the expansion would require an additional $2 million investment in net operating working capital. The tax rate is 40% a. What is the initial investment outlay? b. The company spent and expensed $20,000 on research related to the project last year. 12-1 Would this change your answer? Explain. c. The company plans to use a building that 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?

Explanation / Answer

a. Initial investment outlay = Cost of Equipment + Additional Net Operating Working Capital = $ 18 million + $ 2 million = $ 20 million.

b. This would not change the answer. The $ 20,000 spent on research last year is sunk cost, and is not relevant for the decision making today.

c. The net fair value of the building today is an opportunity cost relevant to the project. Therefore, it should be added to the initial investment outlay, and the initial outlay would be $ 21 million.

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