The company bought some land three years ago for $3.8 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $4.6 million. In five years, the aftertax value of the land will be $5.0 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost $31.44 million to build. DEI’s tax rate is 40 percent. The project requires $1,125,000 in initial net working capital investment to get operational.
I need help finding the:
Cost of plant and equipment
Opportunity cost of land
Investment in additional net working capital
Initial cash outflow
Cost of plant and equipment: The cost of the new manufacturing plant and equipment is stated as $31.44 million.
Opportunity cost of land: The opportunity cost of the land refers to the value of the land if it were used for its next best alternative use. In this case, the land is expected to have an aftertax value of $5.0 million in five years. However, since the company intends to keep the land for a future project, there is no opportunity cost associated with it.
Investment in additional net working capital: The initial net working capital investment required for the project is stated as $1,125,000.
Initial cash outflow: The initial cash outflow would include the cost of the plant and equipment ($31.44 million), the investment in net working capital ($1,125,000), and any other expenses relevant to getting the project operational. Therefore, the initial cash outflow would be the sum of these amounts.
To find the requested values, we'll break them down step by step:
1. Cost of plant and equipment:
The cost of the plant and equipment is given in the question as $31.44 million.
2. Opportunity cost of land:
The opportunity cost of the land is the difference between the current value of the land and the initial cost. In this case, the current value of the land is $4.6 million and the initial cost was $3.8 million. Therefore, the opportunity cost of the land is $4.6 million - $3.8 million = $0.8 million.
3. Investment in additional net working capital:
The initial net working capital investment required for the project is given in the question as $1,125,000.
4. Initial cash outflow:
The initial cash outflow is the sum of the cost of plant and equipment, the opportunity cost of land, and the investment in additional net working capital.
Initial cash outflow = Cost of plant and equipment + Opportunity cost of land + Investment in additional net working capital
= $31.44 million + $0.8 million + $1,125,000
By substituting the given values, we can calculate the initial cash outflow.
To find the required values, let's break down the information provided:
1. Cost of plant and equipment:
The cost of the plant and equipment is given as $31.44 million. This is the amount needed to build the manufacturing plant.
2. Opportunity cost of land:
The opportunity cost of the land is the value that could have been obtained by using the land for its next best alternative use. In this case, the company expects the after-tax value of the land in five years to be $5.0 million. However, the land was appraised last week for $4.6 million. To calculate the opportunity cost, we need to consider the difference between the appraised value and the expected future value, and apply the tax rate.
Opportunity cost = (Expected future value - Appraised value) * (1 - Tax rate)
Opportunity cost = ($5.0 million - $4.6 million) * (1 - 0.40)
Opportunity cost = $0.4 million * 0.60
Opportunity cost = $0.24 million
So, the opportunity cost of the land is $240,000.
3. Investment in additional net working capital:
The investment in additional net working capital is given as $1,125,000. This refers to the funds needed to cover the initial working capital requirements for the project.
4. Initial cash outflow:
To calculate the initial cash outflow, we need to sum up the cost of plant and equipment, the opportunity cost of land, and the investment in additional net working capital.
Initial cash outflow = Cost of plant and equipment + Opportunity cost of land + Investment in additional net working capital
Initial cash outflow = $31.44 million + $0.24 million + $1.125 million
Initial cash outflow = $32.805 million
So, the initial cash outflow is $32.805 million.