A firm is planning a project that will both expand the firm's operations and replace some of the older, less efficient assets of the firm. The new assets will cost the firm $200,000 plus an additional $5,000 for delivery and $25,000 for installation. Old assets being replaced have a book value of $50,000 and can be sold pre-tax for $40,000. The new project will require additional land. The land to be used was purchased three years ago for $75,000 but could be sold today for $140,000 net of taxes. The new project will require an increase of $20,000 in net working capital immediately. What is this project's net investment? Use 40% for the effective tax rate.
A)$350,000
B)$281,000
C)$390,000
D)$346,000

Question

Quizplus · Accepted Answer

The net investment for the project can be calculated as follows:1. Cost of new assets = $200,0002. Delivery cost = $5,0003. Installation cost = $25,0004. Increase in net working capital = $20,0005. Sale of old assets = -$40,000 (cash inflow, so it's subtracted)6. Tax on sale of old assets = 40% * ($40,000 - $50,000) = -$4,000 (since this is a loss, the firm gets a tax shield)7. Opportunity cost of land = $140,000 (since the land could be sold for this amount today, this is the opportunity cost of using it for the project)Adding these together: $200,000 + $5,000 + $25,000 + $20,000 - $40,000 - $4,000 + $140,000 = $346,000.

A Firm Is Planning a Project That Will Both Expand