Incremental Costs Marston Manufacturing Company is considering a project that re
ID: 2719742 • Letter: I
Question
Incremental Costs
Marston Manufacturing Company is considering a project that requires an investment in new equipment of $3,600,000, with an additional $180,000 in shipping and installation costs. Marston estimates that its accounts reveivable and inventories need to increase by $720,000 to support the new project, some of which is financed by $288,000 increase in spontaneous liabilites (accounts payable and accruals).
1. The total cost of Martson's new equipment is ___________ (a. $3,780,000, b. $4,212,000, c. $720,000) and consists of the price of the new equipment plus the _______________________ (a. asset's salvage value, b. assets installation, shipping, and delivery costs.
2. In contrast, Marston's initial investment outlay is ________ (a. $4,212, 000, b. $4,032,000, c. $3,924,000)
3. Suppose Marston's new equipment is expected to sell for $600,000 at the end of its four-year useful life, and at the same time, the firm expects to recover all of its net working capital investment. The company chose to use straight-line depreciation, and the new equipment was fully depreciated by the end of its useful life. If the firm's tax rate is 40%, what is the project's total termination cash flow?
a. $672,000
b. $600,000
c. $360,000
d. $792,000
Explanation / Answer
Answer:
1. The total cost of Martson's new equipment is a. $3,780,000 and consists of the price of the new equipment plus the b. assets installation, shipping, and delivery costs.
Note: Total Cost of Martson’s new equipment = Cost of New Equipment + Additional Cost of shipping and installation = $3,600,000 + $180,000 = $3,780,000
2. In contrast, Marston's initial investment outlay is a. $4,212, 000
Note: Martson’s Initial Outlay / Outflow = Total Cost of New Equipment + Net Increase in Working Capital
Martson’s Initial Outlay / Outflow = $3,780,000 + (Current Assets – Current Liabilities) = $3,780,000 + ($720,000 - $288,000) = $3,780,000 + $432,000 = $4,212,000.
3. The Project's Total Termination Cash Flow = $792,000
Here is the working and calculation:
Additional Note: Tax will be levied on entire sale value of equipment at the end of useful life. Because net gain will be $600,000.
Project’s Total Termination Cash Flow Particulars Amount Expected Sale Value from Equipment $600,000 Less: Tax @ 40% ($240,000) After Tax Sale Value from Equipment $360,000 Add: Recovery of Net Working Capital $432,000 Project's total termination cash flow $792,000