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Incremental costs - Initial and terminal cash flow

Newcastle Coal 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. Newcastle estimates that its accounts receivable and inventories need to increase by $720,000 to support the new project, some of which is financed by a $288,000 increase in spontaneous liabilities (accounts payable and accruals).

The total cost of Newcastle's new equipment is _____________ and consists of the price of the new equipment plus the _____________

In contrast, Newcastle's initial investment outlay is ______________

Suppose Newcastle'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. $600,000
B. $672,000
C. $792,000
D. $360,000

Respuesta :

Answer:

1. $3,780,000

2. $4,212,000

3. Option (C) is correct.

Explanation:

1. Total cost of Newcastle's new equipment:

= Cost of new equipment + Additional cost of shipping and installation

= $3,600,000 + $180,000

= $3,780,000

2. Newcastle's initial investment outlay:

= Total cost of new equipment + Net increase in working capital

= Total cost of new equipment + (Current assets - current liabilities)

= $3,780,000 + ($720,000 - $288,000)

= $3,780,000 + $432,000

= $4,212,000

3. Project's total termination cash flow:

= Expected sale value fro equipment - Taxes 40 % + Recovery of net working capital

= $600,000 - $240,000 + $432,000

= $792,000

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