Question

53. A company is looking to invest in a new asset. The cost of the asset, including shipping and installation costs, is $8.4 million. The company has a buyer for the old asset who is willing to pay $1.2 million. Currently the book value of the old asset is $0. The company will also invest working capital in additional inventory in order to sustain the higher levels of efficiency that come with the new machinery. The total investment in net working capital will be $1.5 million. What is the initial outlay if the company's marginal tax rate is 39%? A. $10.63 million B. $9.17 million C. $8.70 million D. $8.10 million E. $11.10 million

Answer 1

Initial Outlay = Capital Expenditures (for New Asset) + Increase in Working Capital − Inflows on Disposal of Old Assets (Net of Tax)

We consider the after tax inflows on disposal of old assets because the Company will be liable to pay taxes on net earnings realized by selling the old asset.

Net earnings = Inflows from Sale of Asset - Book Value of the Asset as on date of Sale

In the given case,

Initial Outlay = $8.4m + $1.5m - [$1.2m - (($1.2m - $0)*0.39)] = $9.168m

Hence, the correct answer is option B - $9.17 million is the total Initial Outlay.