Question

Toledo, Inc. plans to purchase a new manufacturing plant for a total cost of $5,000,000. The plant will be depreciated to zero over 20 years. Toledo, also has plans to purchase $1,000,000 of new equipment for the plant.   The equipment will be depreciated to zero over 10 years. In addition, Toledo plans to immediately purchase $10,000 of new spare parts for the machinery in the plant. What initial cash flow (CFo) should Toledo use in its capital budgeting analysis if the project is expected to last 20 years?

Answer 1

The initial cash flows in context of capital budgeting analysis means the amount of money paid out or received at the commencement of the project or investment. Usually, the initial cash flow (CF₀) will be an outflow since commencement of any project would require cash outlay and hence will be a negative figure. It is the aggregate of the amount to be invested in a project or investment under consideration.

The initial cash flow (CF₀) of Toledo, Inc, if the company takes up the project is computed as follows:

Initial Cash flow (CF₀) = Capital Expenditure + Increase in Working Capital - Post-tax disposal proceeds (if any)
=>Initial Cash flow (CF₀) = $(5,000,000 + 1,000,000 +10,000) + 0 - 0
=>Initial Cash flow (CF₀) = $6,010,000