CFA Practice Question
Given the following information, what is the required cash outflow associated with the acquisition of a new machine; that is, in a project analysis, what is the cash outflow at t = 0?
Installation charge: $2,000
Market value of old machine: $2,000
Book value of old machine: $1,000
Inventory decrease if new machine is installed: $1,000
Accounts payable increase if new machine is installed: $500
Tax rate: 35%
Cost of capital: 15%
Purchase price of new machine: $8,000
Installation charge: $2,000
Market value of old machine: $2,000
Book value of old machine: $1,000
Inventory decrease if new machine is installed: $1,000
Accounts payable increase if new machine is installed: $500
Tax rate: 35%
Cost of capital: 15%
A. -6,460
B. -8,980
C. -6,850
Explanation: Cost plus installation: ($10,000)
Sale of old machine: $+2,000
Tax effect of sale: ($1,000 x 0.35) = (350)
Decrease in working capital: $1,500
Total investment at t = 0: ($6,850)
Sale of old machine: $+2,000
Tax effect of sale: ($1,000 x 0.35) = (350)
Decrease in working capital: $1,500
Total investment at t = 0: ($6,850)
User Contributed Comments 13
| User | Comment |
|---|---|
| shasha | requirement for net working capital was Decreased, 'coz at t0 NWC was increased by 1,500. |
| junli68 | what does the tax effect of sale mean here? Thanks. |
| chenyx | Both inventory decrease and payable increase are not cash outflow. They both decrease working capital. |
| Ali1 | tax effect of the sale is the book value of the machine multiplied by the tax rate. Becuse you've paid taxes on the rest o the amount depreciated, you only pay tax on the book value. |
| mtcfa | Wrong ALI... the tax you're paying is related to the GAIN on the sale. |
| Birdy101 | (Sale price - BV )* tax rate = tax liability due to the sale |
| vadklim | To chenyx: Due to this decrease in working capital the agregate cash outflow for working capital maintanance was 1500 less than it would be othervise. |
| iambroke | chenyx: simply.....Inventory decreased...therefore you didnt pay that much in cash to acquire it also accounts payable increased...=> more cash in hand. |
| ofabian | t=0 = right now. there shouldn't be any tax cash outflows immediately. |
| JeffAu | Cost of capital 15% totally useless here lol |
| mkunkel28 | I guess it could be implied but it never says anything about selling the old machine... |
| ishanj196 | ^mkunkel28 absolutely true. This is what got me the answer wrong -.- |
| pigletin | why add back decrease in inventory? |